Foisy v. The Queen, docket 98-2859-IT-G

Date: 20000502

Docket: 98-2859-IT-G

BETWEEN:

DANIEL FOISY,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasons for Judgment

Lamarre Proulx, J.T.C.C.

[1] This is an appeal for the 1995 taxation year.

[2] The issue is whether the appellant knowingly, or under circumstances amounting to gross negligence, failed in his 1995 income tax return to report a capital gain on the disposition of qualified shares of a small business corporation, in respect of which gain subsection 110.6(2.1) of the Income Tax Act ("the Act") provides for a $375,000 exemption in computing taxable income. If there was such a failure, it would be necessary to determine the applicability of subsection 110.6(6) of the Act, which provides that the exemption is lost where the taxpayer failed to report the capital gain knowingly or under circumstances amounting to gross negligence, and of subsection 163(2) of the Act, which provides for the assessment of a penalty for deceit and wilful failure to report or where there are circumstances amounting to gross negligence.

[3] When the hearing began, counsel for the respondent told the Court that the appellant had made an election under subsection 110.6(19) on March 5, 1997. Under subsection 110.6(24), he had until April 30, 1995, to make that election without incurring a late election penalty. However, subsection 110.6(26) extends that time period by two years if the penalty provided for in subsection 110.6(29) of the Act is paid. It was therefore possible for him to make the election. The election, which resulted in the deemed disposition of 5,000 shares of Technilab Pharma Inc. ("Technilab") on February 22, 1994, increased the adjusted cost base of the shares, which were actually disposed of on October 4, 1995. Counsel for the respondent filed the following table showing the calculation of the revised capital gain:

[TRANSLATION]

DISPOSITION OF 5,000 SHARES OF TECHNILAB PHARMA INC., OCTOBER 4, 1995

Election (T664)

Fair market value, February 22, 1994 $130,000

Adjusted cost base, February 22, 1994 $22,500

Proceeds of disposition according to election under 110.6(19) $102,000

Adjusted cost base $102,000

Disposition on October 4, 1995

Proceeds of disposition, October 4, 1995 $207,910

Minus: adjusted cost base 102,000

Capital gain $105,910

Revised capital gain (75%) $79,433

Assessed capital gain, August 13, 1997 139,421

Reduction of capital gain in 1995 $59,988

[4] The appeal will therefore have to be allowed at least to enable the Minister of National Revenue ("the Minister") to assess on the basis of the new adjusted cost base.

[5] The appellant testified on his own behalf. He is currently working as a controller at a pharmaceutical company. He is a chartered accountant (CA) and certified management accountant (CMA). Since finishing his schooling, he has worked in the accounting departments of large companies. He was employed at Technilab from January 1987 until 1995. When his employment there ended, he was managing a team of 20 people. Until 1994, he reported directly to the president. In 1994, a new vice-president, finance and administration, came on the scene. That change in the hierarchical situation is what explains the appellant's departure at the end of June 1995.

[6] The appellant's salary when he left in June 1995 was $71,000. He subsequently worked at Vidéotron for nine months at a salary of $85,000. On June 16, 1996, he started a new job, again at a pharmaceutical company, where he is still working today.

[7] During his years at Technilab, he participated in a program for the purchase of shares in his employer. That company's sales went from $3 million to $45 million. When the appellant left the company, he had to dispose of his shares through their redemption by Technilab. A clause in the share purchase contract provided that, when employees left, they had to sell their shares back to Technilab. It was Technilab's lawyer who took care of finalizing the transactions. With the proceeds of disposition from the shares, the appellant purchased shares in public companies.

[8] The appellant said that he does not consider himself or portray himself as a tax expert. He explained that Technilab's tax returns were prepared by an outside accounting firm. All the same, he is the one who has been completing his own tax return since 1986 as well as those of his close relations.

[9] It was difficult for the appellant to explain why he did not report the capital gain of approximately $185,410. He said that a lack of organization accounted for it. He did not consider it essential to report the gain since he was entitled to a $375,000 exemption on the approximate capital gain of $139,057. He was not hiding income on which he had to pay tax. He thought that he would report the gain the following year through an amended return for 1995 once he had had the time to determine the amount of his cumulative net investment loss ("CNIL"). He was not aware that he might lose the exemption if he did not report the gain and thus that it was important to report it. He also explained that he was going through a period of adjustment to a new job. He had lost his wife in 1993 and was having some problems with his children. He had previously reported a capital gain on the sale of an income property in 1983. The same was true in 1985. In 1987, he had sold a cottage.

[10] According to the appellant, it was difficult for him to calculate his CNIL, which had been building up since 1985. This seems to be the reason which, when added to the others, led the appellant to delay reporting the capital gain. The calculation was done by a tax expert whose services he enlisted in October 1996 to minimize the effect of his failure to report. The CNIL was determined to be $19,540. That amount was included in the calculation of the capital gain as at February 22, 1994, referred to in paragraph 3 of these Reasons.

[11] At the end of June or the beginning of July 1996, a former co-worker at Technilab learned that the company's books were being audited by Revenue Canada. The appellant did not express any concerns in this regard.

[12] Serge Diotte acted as the Minister's auditor with respect to Technilab from June to November 1996. He contacted the appellant by telephone in September 1996. He told the appellant that he had noticed share redemptions by Technilab in respect of which the shareholder had not reported the disposition. The appellant apparently told him that he wanted to file an amended return for that purpose. Mr. Diotte told him that it was too late for such an amended return and that he was sending him a proposed assessment. The appellant could then put forward any arguments he might have.

[13] The Minister's auditor recommended the application of subsection 110.6(6) of the Act and the assessment of a penalty under subsection 163(2) of the Act because of the appellant's training in accounting and his work experience. As part of his duties as Technilab's chief financial officer, it was he who met with the Revenue Canada auditors when they came. He knew that capital gains had to be reported since he had already reported such gains. Moreover, the quantum was substantial. Mr. Diotte said that it is easy to calculate the CNIL. The software used to prepare tax returns makes the calculation very easy. The appellant has used such software to prepare his return since at least 1993, as can be seen from his 1993 to 1997 returns found at Tabs 1 to 3 of Exhibit I-1. It is also possible to call Revenue Canada and obtain the amount quickly. These comments were made during Mr. Diotte's examination. We are therefore not dealing with a fact noted in a report after relevant analysis.

Arguments

[14] Counsel for the appellant argued that the Act is a complex piece of legislation. Its difficulty, along with the appellant's state of intellectual exhaustion during the period in question, are what explain the appellant's behaviour, not a guilty intent to evade taxes. How could it have been in his interest not to report the gain? He was a long way from the exemption limit. Would he ever acquire more qualified small business corporation shares? He had not done so with the proceeds of disposition that gave rise to the capital gain. The fact that he has previously reported his capital gains shows that he is a taxpayer who is concerned about presenting a true picture of his income. It is difficult to understand why Revenue Canada gives a bad grade to someone who has always reported his or her capital gains and a good one to those who have never reported any. Revenue Canada seems to be interpreting this as showing that the former knows that capital gains must be reported whereas the latter do not. Can it not be interpreted instead as showing that an individual's usual behaviour is to comply with the Act? Although the appellant did not do so one particular year, his previous conduct shows that he did not intend tax evasion but that his failure resulted from negligence attributable to mental fatigue. The appellant knew that he was entitled to a $500,000 capital gains exemption. So, as he saw it, reporting the transaction to the government was not urgent. He would do it when he had taken the time to correctly calculate his CNIL. He was negligent to some extent, but not so much so that subsections 110.6(6) and 163(2) of the Act apply.

[15] Counsel for the respondent argued that the appellant had an interest in not reporting because the capital gain would reduce the exemption limit. She also pointed out the appellant's accounting experience. He knew that the capital gain had to be reported. Difficulty in calculating the CNIL is not a valid excuse. Moreover, before the Minister's auditor became involved, there was no indication that the appellant intended to report the capital gain.

Analysis and conclusion

[16] I consider it useful in this case to briefly summarize the history of capital gains taxation. I have taken the information from the following works in particular: Lord, Sasseville and Bruneau, Les principes de l'imposition au Canada, 10th ed. (1993), chapters II and VII; and Hogg and Magee, Principles of Canadian Income Tax Law (1995), chapters 3 and 15.

[17] Before 1972, capital gains were not subject to income tax. In 1967, the report of the Royal Commission on Taxation, known as the Carter Commission, recommended that such gains be taxable in the same way as business earnings. In 1969, the White Paper on Taxation recommended the full taxation of capital gains with the exception of those on shares of Canadian public corporations, which would be taxed at 50 percent. The Income Tax Act that came into force on January 1, 1972, provided for a 50 percent tax rate for capital gains.

[18] In 1985, the Act was amended to give individuals a cumulative capital gains exemption that could progressively reach $500,000. That exemption increased gradually: thus, the limit was $20,000 in 1985, $50,000 in 1986 and $100,000 in 1987. It was then supposed to increase by $100,000 each year until it reached a final limit of $500,000 in 1990.

[19] The exemption was said to be cumulative because it was necessary to accumulate the exemptions taken throughout an individual's life. Any exemption amount used in a previous year reduced the available exemption limit.

[20] The increase in the exemption limit stopped at $100,000 in 1987 with the tax reform of that year. The same reform provided that the taxable portion of capital gains would rise to 66 2/3 percent in 1988 and 75 percent starting in 1990. The $100,000 exemption ended in 1994. (The federal budget of February 28, 2000, contains a proposal to bring the inclusion rate for capital gains realized after February 27, 2000, down to two thirds.)

[21] The end to the increase in the tax exemption limit that occurred in 1988 did not apply to qualified farm property or qualified small business corporation shares. For them, the exemption reached its final limit in 1990 and did not end in 1994.

[22] When the $100,000 exemption was repealed in 1994, subsection 110.6(19) of the Act enabled individuals to make an election by which capital property would be deemed to be disposed of on February 22, 1994, and repurchased at its fair market value or some lower value. The elected value became the property's adjusted cost base. The election had to be made within the time set out in subsection 110.6(24) of the Act.

[23] The 1988 tax reform also introduced the concept of "cumulative net investment loss" or CNIL, which is defined in subsection 110.6(1) of the Act. The aim of the CNIL provisions is to delay access to the exemption for individuals who have incurred cumulative net investment losses by reducing the exemption limit by the amount of the CNIL. The loss corresponds to the amount by which investment expenses for the years after 1987 exceed investment income for the same period. "Investment expense" and "investment income" are defined in subsection 110.6(1) of the Act. Investment expenses include expenses incurred to earn income from property and losses incurred on rental property. Investment income is made up mainly of income from property, interest, taxable dividends and rent.

[24] I come now to the heart of this case. Subsection 110.6(6) of the Act read as follows in 1995:

110.6(6) Failure to report capital gain. Notwithstanding subsections (2), (2.1) and (3), where an individual has a capital gain for a taxation year from the disposition of a capital property and knowingly or under circumstances amounting to gross negligence

(a) fails to file a return of the individual's income for the year within one year after the day on or before which the individual is required to file a return of the individual's income for the year pursuant to section 150, or

(b) fails to report the capital gain in the individual's return of income for the year required to be filed pursuant to section 150,

no amount may be deducted under this section in respect of the capital gain in computing the individual's taxable income for that or any subsequent taxation year and the burden of establishing the facts justifying the denial of such an amount under this section is on the Minister.

[25] As we have just read, the penalty for failing to report a capital gain is a harsh one. Not only is the exemption for the unreported capital gain lost and the taxable portion of the capital gain for the year in question required to be included in the individual's income, but an exemption to which the individual is supposed to be entitled throughout his or her life is lost forever. In my view, in the context of section 110.6, it is necessary that the words "knowingly or under circumstances amounting to gross negligence" mean more than an intention not to report the capital gain. If the exemption provided for in subsection 110.6(2) of the Act did not exist, proving such an intention would be sufficient for a finding of gross negligence, since the purpose of not reporting would be to evade taxes. However, in the specific case where an exemption is granted for a capital gain, the failure to report the gain must occur in circumstances in which there is an intention to evade taxes, a malicious intent not to comply with the Act's requirements or an intention to deceive the Minister.

[26] The words used are the same as in subsection 163(2) of the Act. It is to a decision on that provision that I would like to refer. That decision is the now classic decision of Strayer J. in Venne v. M.N.R., [1984] F.C.J. No. 314:

With respect to the possibility of gross negligence, I have with some difficulty come to the conclusion that this has not been established either. "Gross negligence" must be taken to involve greater neglect than simply a failure to use reasonable care. It must involve a high degree of negligence tantamount to intentional acting, an indifference as to whether the law is complied with or not. . . .

[27] It is true that the appellant is trained as an accountant. However, an individual who is an accountant does not necessarily act with guilty intent by not acting in compliance with the Act. Such an individual is entitled to make a mistake and may be entitled to an excuse. The individual's behaviour must be interpreted on the basis of his or her knowledge, it is true, but also on the basis of the circumstances of the act or omission.

[28] The appellant's versions of the events have never changed. He intended to report the capital gain later through an amended return. Doing so was not urgent because he was a long way from exceeding the allowed exemption limit. He would thus have a chance to correctly calculate his CNIL. This is a case of procrastination, as the appellant himself admitted. However, there was no intention on his part to evade taxes or deceive the Minister. The appellant's explanation for his delay is that he had to calculate his CNIL, which he found difficult to do properly at that time. It was a time when, according to his counsel, his intellectual energy was sapped for the reasons referred to in her argument. All the appellant could do was devote his attention solely to the essentials, such as calculating and paying the tax he owed. He thought that calculating the exemption balance could wait since the CNIL had to be calculated and because there was no tax payable involved.

[29] Is the CNIL calculation easy as the Minister's auditor claims or difficult as the appellant claims? I think that I can accept both versions in this case. Something that has become easy for someone who works in the field may be difficult and laborious for someone else who does it only very sporadically. Indeed, the respondent did not adduce any evidence that it is easy to calculate the CNIL. Although the fact that a provision of the Act is difficult to understand does not mean that it does not have to be complied with, such difficulty constitutes nonetheless a factor which came into play in the circumstances of the appellant's omission. I accept that, for the appellant, time and concentration were required. I also accept that for him this difficulty, when added to his state of mental exhaustion, led him to delay reporting the capital gain. That state of exhaustion was described more by counsel for the respondent than by the appellant himself, who was discreet about it. It was caused by his spouse's death in 1993, his parenting problems with his two sons, the fact that he had to leave his long-standing employment with an employer and his adjustment to another job that lasted a shorter time and to the job that followed it.

[30] The Minister's officer said that one reason for the decision to apply subsections 110.6(6) and 163(2) of the Act was that the appellant knew he had to report capital gains since he had already reported some. I have trouble seeing a connection between that fact and the existence of malicious intent to deceive the Minister. Rather, I see it as evidence that the appellant acted properly with regard to the Act, as was argued by his counsel.

[31] To satisfy me that there was malicious intent or gross negligence on the part of the appellant, it would have been necessary to show me how it was in the appellant's interest to hide the capital gain or prove to me that his behaviour was habitually negligent or wrongful. For example, if I had been shown that the appellant was about to pass the $500,000 exemption limit or that purchasing qualified small business corporation shares was a common occurrence for him, I could have seen that the appellant had a culpable interest in hiding information from the Minister. (On the contrary, the evidence showed that the appellant had purchased shares in public corporations, not qualified small business corporation shares, with the proceeds of disposition of the shares that gave rise to the capital gain.) If it had been proved to me that the appellant usually tried to deceive the Minister in his tax returns, I could have seen in the taxpayer's conduct a malicious intent to deceive.

[32] It is my view that the evidence has not shown that, when he committed the wrongful act of not reporting the capital gain, the appellant intended to deceive the Minister or evade some liability to pay tax, or that there were circumstances amounting to gross negligence. The appellant was negligent to some extent but, in view of the reasons for which and the circumstances in which it occurred, that negligence is not serious enough for subsection 110.6(6) of the Act to apply. Consequently, subsection 163(2) of the Act does not apply either.

[33] The appeal is allowed with costs.

Signed at Ottawa, Canada, this 2nd day of May 2000.

"Louise Lamarre Proulx"

J.T.C.C.

[OFFICIAL ENGLISH TRANSLATION]