Archambault v. The Queen, docket 97-3215-IT-G

Date: 20000112

Docket: 97-3215-IT-G

BETWEEN:

RENÉ ARCHAMBAULT,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasons for Judgment

Archambault, J.T.C.C.

[1] To distinguish the notion of capital from that of income, recourse is often had to the metaphor of the tree and its fruit. In the case before us, this is no metaphor. Real trees are involved: 8,100 apple trees, the cost of which was written off as an expense by René Archambault in calculating his profit from the operation of orchards. Mr. Archambault is a major apple grower in Quebec who operates a number of orchards, containing altogether approximately 40,000 apple trees. The Minister of National Revenue (the Minister) disallowed a deduction for this expense on the grounds that it was a capital expense. Counsel for the parties stated that they had been unable to find any decision on point.

[2] In the spring of 1992, Mr. Archambault planted 5,240 apple trees on his land to start a new orchard (Papineau orchard). The cost of the trees was $32,051. During the following winter, they were all killed by frost. Fortunately for him, Mr. Archambault was insured against that risk and, in December 1993, he received insurance proceeds of $61,562, which he included in his income for 1993.

[3] Although the Minister disallowed the $32,051 acquisition cost as a current expense in 1992, he did allow the taxable portion of the insurance proceeds to be reduced by that amount for 1993. The balance of the insurance proceeds, $29,511, was treated in the assessment as business income. According to the Minister's auditor, that represented the cash equivalent of one crop of apples for one year.

[4] The Minister also disallowed as a current expense the acquisition cost for the new trees (1,460 in 1994 and 1,400 in 1995) that Mr. Archambault planted in 1994 and 1995 to replace the ones that had been killed by frost. On the other hand, he did not disallow the cost of the apple trees purchased to replace the apple trees located in other orchards that had not been completely destroyed by frost. According to the Minister's administrative policy, the cost of purchasing apple trees to establish a new orchard is a non-depreciable capital expense added to the cost of the land, whereas the cost of replacing apple trees in an already existing orchard is a current expense. Here, because all the apple trees in the Papineau orchard had been killed, the Minister considered that that orchard had disappeared and that the new apple trees purchased in 1994 and 1995 to be planted in that orchard had been purchased to establish a new orchard.

[5] Mr. Archambault argues that the acquisition cost for all his apple trees is a current expense incurred in the operation of his business. In the alternative, he asserts that, if the Court were to find that the cost of the apple trees was a capital expense, the amount of the insurance payment would also have to be treated as a capital payment and excluded from his income.

[6] Mr. Archambault's appeals—which relate to the 1992 to 1995 taxation years (relevant years)—raise another issue. Some of the workers hired to prune his apple trees and pick his apples refused to be paid by cheque or to provide their names, addresses and social insurance numbers. The Minister disallowed the deduction for these workers' pay because Mr. Archambault had been unable to provide sufficient documentation to support these expenses. Below is a table showing the wage amounts for which Mr. Archambault claimed a deduction, those allowed as expenses and those that were disallowed:

	Wage expenses claimed for pruning and picking	Expenses allowed by the Minister	Expenses disallowed by the Minister	Percentage of wages disallowed in relation to amounts claimed
1992	71,853	44,104	27,749	39%
1993	60,969	53,865	7,284	12%
1994	18,656	6,203	12,453	67%
1995	44,603	24,087	20,516	46%
Total:	196,081	128,259	68,002	35%

[7] Furthermore, the Minister imposed penalties under subsection 163(2) of the Income Tax Act (Act) with respect to the wage expenses that he had disallowed for each of the relevant years.

Facts

[8] Mr. Archambault has worked in apples since he was twelve. For approximately thirty years, he has operated a business purchasing and selling apples.

[9] During the relevant years, Mr. Archambault carried on two businesses: one involved the sale of apples under the name of "René Archambault, pomiculteur"” (commercial operation), the other was the growing of apples, under the name of "Les Vergers René Archambault Enr."” (farming operation). Each business had its own bank account and separate financial statements were prepared for each.

[10] A surprising fact is that the apple trees in the orchards belonging to Mr. Archambault appear on the balance sheet for the commercial operation rather than for the farming operation. Moreover, for accounting purposes, the cost of the 5,240 trees purchased for the Papineau orchard in 1992 was capitalized, and this expense was amortized over a 10-year period. For tax purposes, the cost of these trees was written off as an expense. According to the testimony of Mr. Archambault's accountant, the cost of the trees that were purchased in 1994 and 1995, including the ones to replace the apple trees in the Papineau orchard, was written off as an expense both for accounting and for tax purposes.

[11] It was in 1991 that Mr. Archambault decided to embark on the operation of apple orchards. At first, he operated rented orchards. But he also wanted to operate orchards of his own. That year, he ordered 5,790 apple trees from a nursery for delivery in 1992. Of these, 5,240 would be planted in the Papineau orchard located on a property acquired in 1990, next to Mr. Archambault's residence. The other 550 apple trees would be planted in his other orchards. According to Mr. Archambault, the value of land is not increased by the presence of an orchard. As proof, one may point to the attitude of bankers who pay more attention to crops.

[12] Two days before the end of the eligibility period, Mr. Archambault registered with the Régie des assurances agricoles du Québec (RAAQ) to insure the 5,240 new apple trees that he had just planted on his land. Under the crop insurance program for apples, there are three classes of coverage. Class A coverage applies to apple trees. Class B coverage applies to the quantity and quality of the apple crop for late varieties that reach maturity after the Wealthy (with the exception of the Fameuse). Class C coverage applies to the quantity of the late-variety apple crop reaching maturity after the Wealthy.

[13] Mr. Archambault chose Class A coverage only, since his new apple trees could not produce apples for four or five years. Since the RAAQ insures only trees in good health at the time of registration, the number of trees eligible for the crop insurance program was 4,882, of which only 97% could be insured. The amount of the premium depended on the unit value selected by the grower. Mr. Archambault chose a value of $13 per tree.

[14] During the winter of 1992-1993, Mr. Archambault lost all of his 5,240 apple trees in the Papineau orchard to frost. The RAAQ compensated Mr. Archambault for the loss of his apple trees and paid him $61,562 (13 x 97% x 4,882). The cheque issued by the RAAQ on December 1, 1993 was deposited by Mr. Archambault in his bank account on December 6, 1993.

[15] The RAAQ refused to reinsure the Papineau orchard for fear that Mr. Archambault's land was not suitable for apple growing. Mr. Archambault accordingly decided not to replant all the apple trees that he had lost in 1993 in the same year. He first wanted to be sure that his land was suitable for apple growing. He therefore moved gradually and spread the planting over the period from 1994 to 1998. Thus, according to Mr. Archambault, 1,503 apple trees were planted in 1994 and 1,215 in 1995.

[16] Mr. Archambault estimates that, in the various orchards owned or rented by him, there were approximately 20,000 apple trees during the period from 1991 to 1993. After purchasing the orchard of a Mr. Breton in December 1993, that number reached approximately 40,000 or 45,000, divided among eight orchards.

[17] In the beginning, his orchards largely consisted of standard apple trees, that is, apple trees with a height and spread of 25 feet. These trees have a life span of 50 years. A stepladder is required to prune them and to pick the apples. This makes the work harder and more time consuming and thus involves increased maintenance and harvesting costs. Moreover, such trees produce a higher percentage of apples of inferior quality compared with semi-dwarf or dwarf apple trees.

[18] The semi-dwarfs reach a height of thirteen or fourteen feet and have a spread of approximately ten feet in diameter. The dwarfs are approximately seven or eight feet in height, with a spread of approximately four feet in diameter. The life span of the semi-dwarfs and the dwarfs is 25 years. Therefore, Mr. Archambault decided that it would be more profitable to replace his standard apple trees with semi-dwarf or dwarf apple trees. He estimated that, in 1992, he had approximately 50% standard apple trees and 50% semi-dwarfs and dwarfs. In 1994 and 1995, the majority of his trees were semi-dwarfs and dwarfs. Mr. Archambault said that he replaced his last standard apple trees in 1998.

[19] A study by the Department of Agriculture, Fisheries and Food estimates the replacement rate for an orchard at 4% annually where semi-dwarfs and dwarfs are involved and 2% where standard apple trees are involved. According to that study, the need to replace trees in an orchard is a function both of the trees' life span and of their mortality related to weather conditions. Replacements required for the latter reason are estimated at 1% annually. According to Mr. Archambault, his replacement rate would be between 6% and 10%.

[20] For his commercial operation, Mr. Archambault hires 15 or 20 workers to sort, pack and deliver the apples. This work is carried on throughout the year because Mr. Archambault has year-round apple storage facilities. He also buys apples from other growers. A wages register provides the relevant information, including the name of each employee, the amounts paid to them and the amounts withheld. The Minister allowed in toto the amounts deducted as wage expenses by Mr. Archambault in respect of these employees. Among those whose names appear on the register are orchard employees who work for both of Mr. Archambault's businesses. Two orchard men are generally employed by Mr. Archambault throughout the entire year and work on maintaining the orchard, which includes the planting and pruning of trees. The amount of their wages is shown only on the financial statements of the commercial operation.

[21] Pruning is generally done beginning at the end of February if the weather is fine, but more often in March. Pruning continues until the snow thaws in April. Then begins the work of planting new trees, which must be completed before June. An apple tree planted any later runs the risk of not being able to survive a harsh winter. Moreover, in spring and during the summer, the orchard must be maintained; that involves watering, fertilizing and grass cutting. Apple picking is spread out over two or three weeks: it generally begins in mid-September and may be finished by mid-October.

[22] For the pruning and planting, as well as the apple picking, Mr. Archambault hires casual workers, some of whom receive employment insurance benefits or social assistance and many of these refuse to provide their names and social insurance numbers and insist on being paid cash. Moreover, Mr. Archambault said it was harder to hire pickers for standard apple trees. To pick the apples from these trees requires using stepladders, which makes the work harder and more dangerous. Mr. Archambault stated that he stopped using casual labour for pruning his apple trees in 1995. Since then, he has used only his orchard men.

[23] Mr. Archambault explained as follows the source of the money to pay his pruners[1] and pickers. He said he maintains a petty cash fund in which he always keeps a minimum of $20,000. He said that he used that petty cash only to pay the pruners and pickers. From time to time, however, he may pay some other expenses of his businesses for which he has an appropriate invoice. In such cases, he reimburses himself from the bank account of the particular business.

[24] To replenish the petty cash fund after paying the pruners and pickers in cash, Mr. Archambault asks his daughter-in-law, who is responsible for the secretarial and financial sides of his businesses, to issue a cheque made payable to "cash", which he generally endorses. However, Mr. Archambault does not always have in the bank accounts of either of his businesses the funds required to reimburse the petty cash fund. Mr. Archambault explained that his line of credit is at its lowest point when it comes time to pick the apples. Sometimes he must borrow an additional $50,000 to be able to pay his pickers. According to him, money starts to come in in February/March.

[25] This is why, in 1992, a series of cheques dated December 31 and made payable to "cash" were issued but were only cashed several weeks or months later, some not until July 1993. Mr. Archambault testified that all the cash payments to the pruners and pickers come from the petty cash fund and that he ensures that this fund is replenished so that the pickers and pruners can be paid what they are owed.

[26] One reason for issuing a series of nine cheques dated December 31, 1992, (totalling $25,909) was to create supporting documentation so that that amount of remuneration could be deducted for 1992. As a farmer, Mr. Archambault can calculate his farm income using the cash-based accounting method. When his accountants explained to him that it was not necessary to issue a series of cheques dated December 31, that practice was ended for the following years. The cheques were now cashed almost as soon as they were issued. With the exception of one cheque issued in November 1993, the cheques are now issued during the pruning and picking periods.

[27] At the hearing, Mr. Archambault produced boxes of coupon books bearing the pickers' names. Mr. Archambault described the system used by his business to pay the pickers and keep track of their work as follows. It should first be noted that the pickers are paid by the quantity of apples they pick. The pickers receive $20 for a crate of 18 bushels of apples picked from standard apple trees and $18 for a crate of apples picked from semi-dwarf or dwarf apple trees.

[28] The person responsible for supervising the pickers' work is generally Mr. Archambault's wife and she uses coupons to monitor the quantity and quality of the apples picked by the pickers. The supervisor has books of numbered coupons consisting of three parts. Each of the three parts provides the following information: a number identical to that on the other two parts, the name of the orchard, the name of the picker and the date of picking. One part is given to the picker, the second is placed on the crate of apples by the supervisor and the third is kept in the book by the supervisor.

[29] At the end of the day, the picker receives $18 or $20 for each coupon that he hands in to the supervisor or an equivalent credit if he is not paid every day. The supervisor must then ensure that in the yard or warehouse where the crates are brought there is a number of crates equal to the number of coupons turned in by the pickers.

[30] This system also allows the monitoring of the quality of the apples picked. If it is noted during the sorting that a particular crate contains poor quality apples, either the picker may be warned or steps may be taken to ensure he will not be hired again.

[31] In the box produced as Exhibit A-5, there are 1,314 coupons for 1992, which corresponds to 1,314 crates. Assuming an average cost of $19 per crate, this represents a total wage expense of $24,966. According to Mr. Archambault, this box was supposed to contain just about all of the coupons for that year. On examining Exhibit I-1, Tab 18 (list of payments accepted by the Minister as allowable wage expenses and those that he disallowed), one is forced to recognize that Mr. Archambault is mistaken. This document provides a list of all the cheques issued to persons whose identity could be determined. For the period from January 16, 1992, to October 17, 1992, the Minister calculates that the payments total $43,500. Taking only the payments made between September 1 and October 17 as representing what was paid to the pickers, the amount is $40,871, a figure that is much greater than $24,966.

[32] For 1993, no coupon books were tendered in evidence. For 1994 and 1995, apparently only some of the coupons were produced since I counted 14 for 1994 and 26 for 1995. Mr. Archambault indicated that he had been unable to find the other books for 1993 to 1995. He thought that those books must have been thrown away or destroyed.

[33] In order to find the workers he needed to pick his apples during the relevant years, Mr. Archambault said, he was forced to agree to payment in cash or by cheque made payable to "cash". If he had not agreed to this, the pickers would have gone to neighbouring apple growers, who generally accept these methods of payment. He claims that he would in that event have lost his apple crop because the apples must be picked within a two- to three-week period. Fallen apples have no economic value.

[34] Mr. Archambault said that, following the Minister's audit, he had substantially decreased, if not wholly eliminated, cash payments. He now pays all his casual workers by cheque. He added, however, that he could not be certain if the name of the person appearing on his pay cheques was really the name of the person who provided the services. He said that these people could easily cash their cheques in grocery stores.

[35] Some pickers are willing to give their names and in those cases the cheques are made out in their names. Some insist on getting a cheque made payable to "cash". Where the Minister noted that such a cheque was endorsed by someone other than a member of Mr. Archambault's family, he allowed the deduction for the amount of wages paid. However, when the cheques made payable to "cash" were endorsed by Mr. Archambault or a family member, including his wife or his daughter-in-law, their amounts were disallowed by the Minister. According to the Minister, the taxpayer did not provide sufficient documentation to justify deducting the amount of wages paid to the workers in question.

[36] At the hearing, Mr. Archambault also produced a little brown book containing some information about the wages paid in cash to the apple tree pruners. Pruning the trees requires hiring casual workers for a short time and it is difficult to recruit such labour. Some of these workers are receiving employment insurance benefits. Others already have a job and are available only three days a week. Like the coupon books, this book was not made available to the Minister's auditor.

[37] Mr. Archambault said that, every time he pays his pruners, he tells his daughter-in-law who records the amount in the brown book. In addition, when he needs to replenish the petty cash fund, he has his daughter-in-law make out a cheque payable to "cash". The little brown book does not contain the names of the persons to whom the wages would have been paid nor the payment dates for 1992, 1993 and 1994. It provides only the following kind of information: [TRANSLATION] "pruning — cash — $520". However, in respect of those years, it does contain information—number, date and amount—about the cheques that would have been issued to replenish the petty cash fund.

[38] The following two tables summarize the information contained in the brown book. The first shows the total that Mr. Archambault would have paid, and the second, the total reimbursements to the petty cash fund:

Table of expenses

	Pruning	Planting	Maintenance and picking	Total
1992	13,409	11,000	2,500	26,909
1993	21,023			21,023
1994	16,286			16,286
1995
Total	50,718	11,000	2,500	64,218

Table of reimbursements

	Amount paid out	Amount reimbursed	Amount not reimbursed
1992	26,909	26,909	0
1993	21,023	7,000	14,023
1994	16,286	12,453	3,833
1995

[39] According to Mr. Archambault, all the wages he claimed with respect to his casual pruning and picking workers appear on the statement of income for the farming operation. However, there is no record of wages similar to the one used in his commercial operation. Mr. Archambault stated that none of the employees involved in packing apples worked as a picker at harvest time. He said they were too busy sorting and packing the apples. For them, it was a very busy time. In addition, Mr. Archambault confirmed that none of the wages paid to the casual pickers and pruners were recorded in the payroll records for the commercial operation.

[40] Mr. Archambault's daughter-in-law also testified at the hearing and confirmed that the compensation paid to the casual pruners and pickers was recorded in the financial statements of the farming operation and that the amount indicated under [TRANSLATION] "wages and payroll taxes" includes the premiums paid by the farming operation to the Commission de la santé et de la sécurité du travail du Québec (CSST) in relation to the compensation paid to these casual pruners and pickers.

[41] Before concluding this exposé, it might be added that, according to Mr. Archambault, he had not used the money in the petty cash fund for personal needs. Some of his personal expenses, such as property taxes and car payments, are paid from his business's bank accounts. In calculating his income from business, such expenses are not deducted. They are instead recorded as withdrawals in his proprietor's equity account.

Analysis

Under-the-table compensation

[42] The Minister partially disallowed the deduction of wages claimed by Mr. Archambault in calculating his income from his farming operation. This essentially involves the compensation paid to the pruners and pickers, for which the Minister was unable to obtain sufficient supporting documentation.

[43] It must be pointed out that the Minister allowed as an expense the compensation paid to those individuals even though the only supporting documentation was a cheque payable to "cash", provided that the cheque had been endorsed by someone other than a member of Mr. Archambault's family, and even if there were no wages records. The expenses that were disallowed are those for which the taxpayer provided no supporting documentation other than cheques payable to "cash", endorsed by Mr. Archambault or members of his family.

[44] Section 230 of the Act requires a taxpayer carrying on business to keep records. However, failure to comply with that provision does not necessarily mean that a taxpayer will be unable to prove his expenses. Associate Chief Judge Christie provided a very good summary of the state of the law on that issue in Kay v. Canada, [1994] T.C.J. No. 487, para. 9:

It may be appropriate to say something about taxpayers keeping records and books of account. Under subsection 230(1) of the Income Tax Act every person carrying on business and every person who is required to pay taxes shall keep records and books of account in such form and containing such information as will enable the taxes payable under the Act to be determined. Failure to comply with the subsection will not, of itself, result in the dismissal of an appeal against a reassessment of liability to income tax. But it could interfere with an appellant's ability to discharge the burden of proof on him of showing that, on a balance of probability, the reassessment is in error. This was recently dealt with by the Federal Court of Appeal in Sidhu v. M.N.R., 93 D.T.C. 5453. Mahoney J.A. in delivering the judgment of the Court said at page 5454-5:

"The requirement of s. 230(1) may fairly be characterized as absolute but the consequence of not complying is liability to conviction of an offence under s. 238(2), not necessarily a conclusion that transactions which ought to have been recorded did not occur. The failure to record transactions will inevitably handicap a taxpayer seeking to discharge the burden of proving that they took place but the responsibility of the trial judge in such circumstances is to decide, on a balance of probabilities having regard to all the evidence and its credibility, whether any, all or none took place. The proper approach was demonstrated by Strayer, J., in Schwartz v. Her Majesty the Queen, 87 D.T.C. 5274 at 5275.

'The law places the onus on the taxpayer in such cases to prove wrong the Minister's reassessment on the basis that the taxpayer is in a better position to prove what actually happened, if he chooses and is able to do so. Unfortunately, the plaintiff has not been willing or able to particularize in any way the purchases made by him. He has confirmed on many occasions that the figures provided by his accountant as to his total purchases were correct. If he had made any effort to corroborate this and his oral evidence had seemed forthcoming and credible, it might have been possible to find in his favour even in the absence of any vouchers, receipts or other written records. Unfortunately neither of these requirements were met.' "

[45] Judge Bowman expressed himself in a similar fashion in Neeb v. Canada, [1997] T.C.J. No. 13, para. 39:

I do not think that the evidence is sufficiently reliable to justify my concluding that his income should be reduced. Moreover, as I stated above, the attack on the assessment starts with what the Minister assessed and attempts to reduce it by certain expenses and losses. A person who files no returns of income, keeps no records or, in order to avoid detection, destroys such rudimentary records as he may keep after their purposes has [sic] been served, faces a formidable task in challenging an assessment of the type involved here. The Income Tax Act requires that a taxpayer keep records of the business that he or she carries on. While the failure to keep records is not an absolute bar to deductibility, if expenses can otherwise be proved (Weinberger v. M.N.R., 64 D.T.C. 5060), nonetheless where a person deliberately puts himself in a position in which he cannot establish his income he is the author of his own misfortune.

[46] In the instant case, Mr. Archambault agreed to pay some workers under the table as these workers clearly did not want to leave any traces of the compensation they received for their services. Mr. Archambault argued necessity to explain his conduct. According to him, it would have been difficult if not impossible to hire the casual workers required to pick the apples if he had acted otherwise.

[47] I have no difficulty agreeing that Mr. Archambault may have found himself in such a situation. It is well known that there is a flourishing underground economy in Canada. A number of people, including the Auditor General of Canada, have provided estimates of the scope of this phenomenon. It is a situation that is totally unfair to those Canadian taxpayers who report their income and pay their taxes.

[48] I can understand that some people, like Mr. Archambault, may in fact find themselves forced to participate in this underground economy primarily because of competition and the need to find people to do the work that must be done. However, by agreeing to participate in such activity, a taxpayer runs the risk of being unable to justify the expenses incurred in relation to it. This is particularly true when a taxpayer keeps no records of the names of the workers and the amount, date and nature of each payment.

[49] To be successful in discharging his burden of proof, a taxpayer must be able not only to show that an expense was incurred for the purpose of producing income but also to establish the year in which the expense was incurred, if the taxpayer uses accrual accounting, or the year in which the outlay was made if, as in this case, the taxpayer uses cash-based accounting.

[50] Furthermore, it is important to note that the appeal concerns the amount of tax assessed. That amount depends in part on the amount of net income earned by the taxpayer, which in turn depends on revenues received and the expenditures made to earn them. If a taxpayer uses unreported income to pay compensation under the table, the net amount of the taxpayer's income is unchanged and there is no reason to change the tax assessed.

[51] According to Mr. Archambault, the evidence supporting his claims is as follows. First, the wage amounts disallowed by the Minister total $68,002. As evidence that he paid these amounts, Mr. Archambault produced 25 cheques totalling $68,002. All these cheques are payable to "cash" and are endorsed either by him or his daughter-in-law (most frequently by both). According to Mr. Archambault, the purpose of these cheques was to replenish his petty cash fund, which was used to pay his expenses relating to the under-the-table work. He also states that he did not use this money for personal purposes and that his financial statements reflect all his sales.

[52] As well, there is the brown book with a list of the payments made by Mr. Archambault to compensate his casual workers hired for apple tree pruning, planting and maintenance and for apple picking. There are also the coupons given to the pickers, which coupons were said to have all been produced for 1992.

[53] In addition to the coupons and the brown book, there is the fact that Mr. Archambault paid to the CSST amounts varying between $1,433 and $6,144, which would confirm that the amounts that he deducted for wages did indeed represent wages. Why would he have paid premiums to the CSST if the money had been used for personal purposes?

[54] Lastly, counsel for Mr. Archambault noted that the audit of Mr. Archambault's personal accounts turned up no anomalies in the deposits or in the disbursement. Apart from the records for the casual workers employed in the farming operation, the taxpayer's accounting records are all satisfactory and, with the exception of the problem raised here, Mr. Archambault's tax file is beyond reproach.

[55] That is Mr. Archambault's position. Does the evidence before me support his claims? On a closer look at the evidence provided by Mr. Archambault, the situation is not nearly as clear as he describes it. There are a number of inconsistencies in his statement of the facts and I find some of the facts puzzling.

[56] First of all, there is the fact that Mr. Archambault does not seem to have deducted all his wage expenses for pruning in 1993 and 1994. He seems to have restricted himself to those expenses for which his petty cash fund would have been reimbursed. Exhibit I-1, Tab 19, contains an auditor's worksheet itemizing nearly all the amounts deducted as wages in 1993, that is, $60,968.83 out of $61,674.33. Of this amount of $60,968.83, the auditor disallowed three amounts totalling $7,284. With the exception of $66 relating to January 7, 1993, all the amounts relate to a period extending from May 6, 1993 to December 30, 1993. There is no indication that the pruning expenses totalling $21,023 that are referred to in the brown book were deducted by Mr. Archambault, except for an amount of $7,000. For 1994, the situation is basically the same (see Exhibit I-1, Tab 20).

[57] Based on the data provided in the brown book, the expenses incurred by Mr. Archambault were apparently greater than those he is claiming as a deduction: $14,023 for 1993 and $3,833 for 1994.[2] Why did he not claim these expenses? According to the data in the brown book and Mr. Archambault's testimony, these amounts were paid out of the petty cash fund, for the pruners. I do not remember Mr. Archambault providing any explanations on this subject.

[58] Analysis of the evidence produced by Mr. Archambault reveals another surprising fact. In his testimony, Mr. Archambault insisted that the amounts disallowed were related to picking expenses. A large part of his testimony described apple picking and the difficulty in hiring casual workers to do the picking. However, the evidence shows that the expenses disallowed for the first three years at issue are almost entirely related to pruning costs. It is only in respect of the last year at issue that the expenses disallowed relate in any substantial way to apple picking costs.

[59] With the exception of 1992, the activities described in the brown book are all limited to tree pruning. For 1992, the expenses, which total $26,909, all relate to pruning, with the exception of $11,000 for planting apple trees and $2,500 for [TRANSLATION] "maintenance and picking". In 1992, the Minister disallowed an amount of $27,749 as a deductible expense. That amount included expenses of $26,909 detailed in the brown book. Therefore, for that year, only $840 (27,749 – 26,909) and a part of the $2,500 for "maintenance and picking" could relate to compensating pickers. The remainder of the expenses for 1992 and all those for 1993 and 1994 relate to pruning costs.

[60] 1995 is the only year for which the Minister disallowed a major expense for the pickers' wages: this was an amount of $20,516. Mr. Archambault said that, beginning in 1995, he did not hire casual workers for pruning his apple trees but used his orchard men instead. That would explain why there is nothing in the brown book concerning pruning costs for 1995. However, this version of the facts is not fully consistent with the reality. Included among the cheques payable to "cash", the deduction of whose amounts as expenses was disallowed by the Minister for 1995, there are two that are marked as being [TRANSLATION] "for pruning": one for $1,840 and the other for $2,522. In addition, a cheque for $3,000 is marked [TRANSLATION] "for loan", which clearly represents a non-deductible expense.

[61] It is important to note that Mr. Archambault took the same position in his discussions with the tax auditor, namely, that the expenses paid to "cash" seemed to be related more to pickers than to pruners.

[62] Another explanation provided by Mr. Archambault is problematic. This one relates to how he financed his expenses. According to him, the cash payments to his pruners and pickers were financed wholly out of his petty cash fund. However, when the cash flows are analysed in terms of the pruning, planting and picking periods, it can be seen that the petty cash fund was in a deficit position over a long period in the relevant years, and that is so even if one assumes that it was fully replenished at the beginning of January 1992.

[63] The table below illustrates the cash flows in Mr. Archambault's petty cash fund using two different assumptions: first, that the fund's opening balance in 1992 was $20,000 and, second, that the balance on that date was zero. The first assumption is based on Mr. Archambault's statement that his petty cash fund was always kept at $20,000. As will be seen, this statement by Mr. Archambault is not exact.

[64] In the table, the expenses are divided up according to the seasons during which they could be expected to be incurred and the reimbursements are indicated for the periods corresponding to the cashing of the cheques. It should also be added that the reimbursements made in 1995 are not recorded in the brown book. I have nonetheless assumed that the reimbursement cheques (with the exception of the cheque marked "for loan") were used to replenish the petty cash fund.

Petty cash fund cash flow by expense[3]

Activity	Date	(Expense) or reimburse- ment	Balance (deficit balance)	Balance (deficit balance)
	1992		Assumption 1	Assumption 2
Opening balance	January 1992		20,000	0
Pruning	February-April 1992	-13,409	6,591	-13,409
Planting	May to June 1992	-11,000	- 4,409	- 24,409
Picking	July-Oct. 1992	- 3,340
Reimbursement	October 1992	840	- 6,909	-26,909
Reimbursement	November 1992	1,000	- 5,909	-25,909
	1993
Reimbursement	January 1993	2,000	- 3,909	-23,909
Pruning	February-April 1993	-21,023
Reimbursement	February-April 1993	12,209	- 12,723	-32,723
Reimbursement	May to August 1993	11,984	- 740	-20,740
Reimbursement	November 1993	7,000	6,261	-13,740
	1994
Pruning	February-April 1994	-16,286
Reimbursement	February-April 1994	12,453	2,427	-17,573
	1995
Reimbursement	April-August 1995	4,362	6,789	-13,211
Picking	Sept. – Oct. 1995	-17,516
Reimbursement and final balance	Sept. – Oct. 1995	13,154	2,427	-17,573

[65] Assuming that all expenses recorded in the brown book were actually incurred and that there was $20,000 in the petty cash fund in January 1992, the above table shows that Mr. Archambault's petty cash fund fell into a deficit position in May or June 1992, that Mr. Archambault was accordingly unable to pay all the expenses indicated from that time on, and that the fund remained in a deficit position until after the apples had been picked in October 1993.

[66] The question thus arises as to how the pruning and picking activities were financed during that period when the petty cash fund was in a deficit position. The evidence is silent on this point. One may wonder whether part of these expenses might have been paid from income not reported by Mr. Archambault. Obviously, this is mere conjecture. The fact remains, however, that an analysis of the cash flows does not corroborate Mr. Archambault's testimony that he was able to pay out of his petty cash fund all those amounts that were paid in cash.

[67] I must point out that my initial assumption was that, at the beginning of the relevant period, namely January 1992, the fully replenished petty cash fund stood at $20,000. This is the assumption most favourable to Mr. Archambault. However, it is far from certain that it is reasonable. Indeed, the brown book provides data for 1990 and 1991 that are comparable to the figures for the 1992 to 1994 period. These data would seem to indicate that Mr. Archambault also used his petty cash fund to make under-the-table payments in 1990 and 1991.

[68] If the petty cash fund was in a deficit position at December 31, 1992—as the above cash flow table shows—even on the more favourable assumption, it becomes just as reasonable to assume that the opening balance on January 1, 1992 was zero. On this latter assumption, Mr. Archambault would not have been able to pay all the compensation that he claims to have paid, since his petty cash fund would have been in a deficit position from the time of the pruning season in 1992 and would have remained so for the remainder of the relevant years.

[69] Mr. Archambault's version of the facts thus suffers from inconsistency, and this undermines its credibility and, furthermore, lends support to the view that the payment of those expenses could have been financed from sales income not reported by Mr. Archambault.

[70] The fact that Mr. Archambault paid premiums to the CSST is not enough for me to determine conclusively that he paid all the wages he is seeking to deduct as eligible expenses. First of all, I do not have all the evidence that would allow me to establish whether the premiums paid to the CSST correspond to higher wages than those recognized by the Minister as eligible expenses. In addition, even if this were the case, it would not necessarily prove that the expenses that were disallowed were incurred by Mr. Archambault in the taxation years in respect of which he claimed their deduction. Also, the fact that the wage amount which is in excess of the amount recognized by the Minister may have been financed from unreported income stands in the way of Mr. Archambault's showing that the amount of tax assessed by the Minister is incorrect.

[71] The inconsistencies in Mr. Archambault's evidence are a good illustration of how difficult it is to prove expenses where one has deliberately chosen not to keep proper records of such expenses and has agreed to pay one's casual workers under the table.

[72] All in all, Mr. Archambault's evidence did not show on a balance of probabilities that the Minister incorrectly assessed the amount of his taxable income and his tax. By agreeing to pay the pruners and pickers under the table and by not taking care to keep detailed records of the amounts he paid, Mr. Archambault ran a very high risk that the deduction of his expenses would be disallowed. There was a heavy burden upon him and he was unable to discharge that burden. I believe it is fair to state here that Mr. Archambault has been the author of his own misfortune.

Cost of planting

[73] To decide on the tax treatment of the cost of the trees that Mr. Archambault purchased for planting in 1992 in the Papineau orchard and of the cost of the trees that he purchased in 1994 and 1995 to replace the ones that had been killed by frost in 1993, it is important to begin by determining the nature of the asset involved.

[74] Once the trees have been planted in the ground, are they separate assets or rather assets forming part of the land which have completely lost their distinctiveness and whose cost should be added to the cost of the land? In the latter case, the trees could be likened to a brick that is incorporated into a building and which, once it has been incorporated, loses its individuality. The asset owned after that is not a brick but a building. In this case, once the apple trees were planted, did they lose their individuality so that one could say that from that time on Mr. Archambault owned nothing but a piece of land?

[75] In my view, trees planted in the ground do not lose their separate individuality. First, each tree that is planted is individually capable of generating income, just as each car in a fleet belonging to a car rental business is capable of generating income. In my opinion, the trees are as distinct as each rental video owned by a video store. Each video may be rented and generate income for the business.

[76] The fact that the tree has to be planted in the ground and feeds on nutrients in the ground does not change this fact. A car manufacturer has to own machinery in order to build cars. A number of the machines must be securely attached to the floor and the walls of the plant and are operated electrically. Thus, the fact that a tree is planted, that it requires nutrients from the soil in order to be productive, does not really make it different from a machine that is attached to a building and needs electricity in order to produce.

[77] In conclusion, I believe that each tree is an asset that is separate from the ground in which it is planted and that it is not appropriate to add the cost of each of these assets to the cost of the land. This result appears to me to be fully in accord with Canada's tax system. Indeed, it is interesting to note that, among the depreciable assets described in the Income Tax Regulations (Regulations), a distinction is made between land and the building constructed on it. The fact of constructing a building's foundations does not mean that the building is incorporated into the land on which it is located. Such an asset is referred to in Class 3 of Schedule II of the Regulations.

[78] A road, sidewalk, airplane runway, parking area, storage area or similar surface construction is also treated, in Class 1 of Schedule II, as property separate from the land on which it is found. Even a fence is treated as a separate asset in Class 5. There is thus nothing surprising in the conclusion that a tree is an asset that is distinct from the land on which it is planted. Furthermore, in sections 1702 and 1703 of the Regulations care was taken to make it clear that neither land nor a tree is a depreciable asset.

[79] It remains to determine the nature of the trees purchased by Mr. Archambault in 1992 and in 1994 and 1995. More specifically, it must be determined whether the trees constitute capital assets whose purchase price would be subject to the prohibition set out in paragraph 18(1)(b) of the Act, which provides that

18(1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of

. . .

(b) an outlay, loss or replacement of capital, a payment on account of capital or an allowance in respect of depreciation, obsolescence or depletion except as expressly permitted by this Part.

[80] There is no doubt that, in this case, the expense was incurred in order to earn income from a business and is thus not subject to the limitation set out in paragraph 18(1)(a) of the Act.

[81] In this case, Mr. Archambault purchased his apple trees in order to produce apples for sale. These are not trees that were planted to be sold—as is the case with Christmas trees, for example—which would consequently be part of the taxpayer's inventory. In this case, Mr. Archambault's inventory is the apples produced by the apple trees, and not the apple trees themselves.

[82] The apple trees in this case have an estimated life span of approximately 25 years. In addition, it takes four or five years before a newly planted tree can produce. In fact, it takes eight years for a tree to reach maximum production. When a taxpayer like Mr. Archambault purchases an apple tree with the intention of keeping it for approximately 25 years, it seems clear that the purpose of that taxpayer is to obtain an enduring benefit.

[83] What is involved here is certainly a more enduring benefit than that obtained by a person operating car rental business from the purchase of a vehicle. It is even more enduring than a videocassette whose economic life sometimes does not exceed a few months. With regard to the latter case, it is not surprising that the government has seen fit to assign to Class 12 property in Schedule II of the Regulations a capital cost allowance rate of 100%. Automotive equipment is listed in Class 10, which provides for capital cost allowance of 30% per year.

[84] The trees purchased by Mr. Archambault thus possess all the attributes of a capital asset. They are property that was acquired for the purpose of earning income and that has a considerable life span. Their purchase is a one-time expense and that expense procures an enduring benefit for the taxpayer. The fact that an apple tree may be killed by frost a few months after it is planted in no way alters its nature as a capital asset; no one would think of treating a car purchased by a rental business as property included in inventory just because it was in an accident after having been used for a few months.

[85] There is no lack of case law in this area. As an illustration, one may cite the decision of the Supreme Court of Canada in British Columbia Electric Railway Company Limited v. Minister of National Revenue, 58 DTC 1022, which contains this passage at page 1025:

Neither the Canadian nor the Imperial Act attempts to define the term "capital" nor, in the case of our Act, what is meant by a payment on account of capital.

[English cases dealing with similar payments]

The question has, however, been discussed in a number of cases. In Vallombrosa Rubber Co. Ltd. v. Farmer, (1910) 5 T.C. 529 at 536, Lord Dunedin said in part:

Now, I don't say that this consideration is absolutely final or determinative, but in a rough way I think it is not a bad criterion of what is capital expenditure as against what is income expenditure to say that capital expenditure is a thing that is going to be spent once and for all, and income expenditure is a thing that is going to recur every year.

In Atherton v. British Insulated and Helsby Cables Ltd., (1925) 10 T.C. 155 at 192, [1926], A.C. 205, Lord Cave said that:

. . . when an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, I think that there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital.

[86] Counsel for Mr. Archambault produced an excerpt from the book by Marc Papillon and Robert Morin entitled Impôt sur le revenu des particuliers et sociétés, 15th edition, 98/99 Éditions Mérin, at page 256, that provides this brief description of the criteria for distinguishing between a current expenditure and a capital expenditure:

[TRANSLATION]

DISTINCTION BETWEEN A CURRENT EXPENDITURE AND A CAPITAL EXPENDITURE[4]

Various criteria may be used to distinguish a current expenditure from a capital expenditure.

Enduring Benefit

A capital expenditure is an expenditure that was incurred once and for all with a view to bringing into existence an enduring asset or advantage for the benefit of a trade.

Maintenance or Betterment

An expenditure for maintenance is intended to restore a property to its original condition. An expenditure that results in improving the property beyond its original condition will be a capital expenditure. A decision to capitalize the amounts must be made without regard to whether the market value of the property does or does not increase as a result of the expenditure incurred.

Integral Part or Separate Asset

A repair is a current expenditure. The acquisition of a separate asset (that does not have to be integrated with another asset) is an expenditure of a capital nature.

Examples

Replacing the propeller of a ship is a current expense because it is an integral part of the ship.

The acquisition of a lathe in a factory is the acquisition of an asset that is not an integral part of the factory. That purchase constitutes a capital expenditure.

Relative Value

A business may establish a line of demarcation between current expenditures and capital expenditures based on a monetary criterion determined in relation to the investment operations of the business. All capital purchases whose cost is less than $2,000 are recorded under expenses, for example. This arbitrary norm must be reasonable in the circumstances and be based on ratios such as:

expense/value of the asset, or

expense/average maintenance and repair cost.

Example

The purchase of a spark plug constitutes a current expenditure, while the purchase of an engine is a capital expenditure.

Acquisition of Used Property

If repairs are required to put acquired used property in good working order, the cost of such work is regarded as being part of the cost of acquisition and can thus be capitalized.

Inventory Asset

Property purchased for resale at a profit is not depreciable property but is part of the inventory of the business. Where the same property is purchased for use in the taxpayer's business, it is regarded as depreciable property.

[87] As may be noted from this analysis, it is important to decide whether a tree is an integral part of the land or a separate asset. Once it has been determined that each apple tree purchased by Mr. Archambault is a separate asset, it is relatively easy to conclude that the cost of replacing a tree killed by weather conditions or destroyed because it has ceased to be productive after twenty-five years is an expense for the replacement of capital under paragraph 18(1)(b). Replacing a tree is not the same as replacing the propeller of a ship.

[88] Accordingly, I believe that the costs incurred to plant trees replacing existing trees in an orchard are also—contrary to the Minister's administrative policy—capital expenses which are subject to the limitation set out in paragraph 18(1)(b) of the Act. It seems to me to be entirely beyond question that, when a car rental business replaces part of its fleet of cars every year, that replacement cost is not a current expenditure. The new cars are added to the Class 8 assets of the owner of the car rental business. I see no reason to come to a different conclusion with respect to a fruit tree, especially since fruit trees—apple trees in this case—have a much greater life span than a rental car.

[89] In conclusion, the apple trees purchased by Mr. Archambault in 1992, and those purchased in 1994 and 1995, are capital assets and their cost cannot be deducted because of the prohibition in paragraph 18(1)(b). It is unfortunate that the Regulations expressly provide that trees are not depreciable assets. Some assets described in Schedule II of the Regulations have a longer life span than semi-dwarf or dwarf apple trees and yet a taxpayer is allowed to claim capital cost allowance with respect to those assets.

[90] The elimination of a tree, for example, when it is destroyed by weather conditions or simply replaced with another when no longer productive, can give rise only to a capital loss that can only be deducted if there is a capital gain. As is the case for many other taxpayers, it is probable that a farmer would not have enough capital gains to take advantage of a capital loss deduction. That loss will therefore have to be carried over to other years. In some cases, it will be possible to deduct the capital loss only on the sale of the farm, supposing that it is sold at a profit. It would therefore be desirable to amend the Regulations so that fruit trees would be regarded as depreciable assets, just like a fence or a barn.

Treatment of the insurance proceeds

[91] Let us turn now to the tax treatment of the insurance proceeds received by Mr. Archambault in 1993. In view of the conclusion that the trees covered by the crop insurance program were capital assets, the compensation received for the loss of those trees is also a payment on account of capital and not on account of income.

[92] The Minister's auditor assumed that the part of the proceeds corresponding to the cost of purchasing the trees in 1992 was a capital payment, and that the balance represented compensation for the production lost by the taxpayer. If I understood the auditor correctly, the $29,511 balance represented compensation replacing the income Mr. Archambault could have earned from an apple crop.

[93] Considering the information found in Exhibit A-2 which describes the terms and conditions of the crop insurance program in which Mr. Archambault was enrolled, it is clear that he had only insured the value of his apple trees since he only chose Class A coverage under the program. Obviously if, in addition to Class A coverage, he had chosen Class B or Class C, a portion of the proceeds might have represented income for Mr. Archambault. Here, as a new planting was involved, Mr. Archambault had no interest in being protected against the risk of either quantitative or qualitative crop loss. Mr. Archambault had to wait for four or five years before getting a crop. In conclusion, the proceeds received by Mr. Archambault compensated him only for the loss of the apple trees. The $61,562 thus represents a capital payment.

[94] According to paragraph (f) of the definition of "proceeds of disposition", in section 54 of the Act, compensation for property damaged and any amount payable under a policy of insurance in respect of damage to property, except to the extent that such compensation or amount has within a reasonable time been expended on repairing the damage, constitutes proceeds of disposition.

[95] The parties made no submissions concerning whether Mr. Archambault had replanted the trees within a reasonable time. At first glance, however, I would think it quite reasonable to exclude at least the cost of planting the trees for 1994 since that year was the first opportunity that Mr. Archambault had to replant. Since he received the proceeds in December 1993, Mr. Archambault could not replant before the spring of 1994.

[96] Was it reasonable for Mr. Archambault to decide to replant the orchard over several years to ensure that the land was suitable for that type of crop? Since I received no submissions from counsel on that matter, I do not think it would be prudent to embark upon an examination of it.

[97] I do believe, however, that the question in issue can be resolved on another basis. Even if a portion of the proceeds paid out by the Régie des assurances agricoles were part of the proceeds of disposition for the trees killed in 1993, it is impossible for me to determine whether a capital gain was realized because no evidence as to the adjusted cost basis (ACB) of the trees was produced at the hearing.

[98] First, since the Minister considered that the purchase price of the trees should be capitalized and thus merged with the cost of the land, it is not surprising to note that the Minister did not indicate the ACB of the trees in his Reply to the Notice of Appeal. Moreover, the evidence given at the hearing is incomplete as far as determining the ACB of these trees is concerned. In addition to the cost of the trees, many other costs would have had to be provided, in particular, the cost of wages paid for planting them.

[99] As the Minister has assessed the taxpayer on the basis that the taxable portion of the insurance proceeds was income from business and since the taxpayer has shown that these proceeds were not part of his income from business, it was up to the Minister to prove the ACB of the trees, which he did not do. Since I cannot determine what the taxpayer's capital gain on the disposition of the trees in 1993 would have been, I find that the $29,511 must be excluded from his income and should not be included as a taxable capital gain.

Penalties

[100] The Minister had the burden of establishing that Mr. Archambault knowingly or under circumstances amounting to gross negligence made a false statement in reporting his income. All that the Minister did was establish that the taxpayer did not provide the supporting documents required in order for him to be able to deduct the wages paid to the casual workers hired for pruning the apple trees and picking the apples. In my opinion, the Minister failed to discharge his burden.

[101] While I found that Mr. Archambault did not succeed in showing the amount of his expenses for the wages of his casual workers, that does not necessarily mean that he did not incur the expenses. Just as I was not convinced on a balance of probabilities as to the amount of the expenses that Mr. Archambault incurred for the pruning of his apple trees and the picking of his apples, so also was I not convinced that Mr. Archambault had necessarily made a false statement in claiming a deduction for his expenses.

[102] The failure to keep appropriate records, thus making it harder to establish the amount of his expenses, does not necessarily mean that a taxpayer made a false statement in his return. I would have had to be convinced on a preponderance of evidence that the amounts expended by Mr. Archambault were spent for personal purposes or that he did not report significant amounts of income and that he knew or ought to have known in claiming the deduction of personal expenses or in not reporting his income that he was making a false staement in his return.

[103] In view of the Minister's evidence, I am not convinced that Mr. Archambault made a false statement in his income tax returns when he claimed a deduction for expenses that were disallowed by the Minister.

[104] For these reasons, Mr. Archambault's appeals are allowed and the assessments are referred back to the Minister for reconsideration and reassessment on the basis that the amount of $29,511 should be excluded from his income for the 1993 taxation year and that the penalties assessed under subsection 163(2) of the Act in respect of all the relevant years are unfounded, the whole without costs.

Signed at Drummondville, Quebec, this 12th day of January 2000.

"Pierre Archambault"

J.T.C.C.

[OFFICIAL ENGLISH TRANSLATION]

Translation certified true on this 19th day of January 2001.

Erich Klein, Revisor

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