Carlson v. The Queen, docket 95-1748-IT-G

Date: 19980103

Docket: 95-1748-IT-G

BETWEEN:

ORJAN CARLSON,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasons for Judgment

(Delivered orally from the Bench in Toronto, Ontario, on September 10, 1997)

Hamlyn, J.T.C.C.

[1] This is in the matter of Orjan Carlson and Her Majesty the Queen. From the Statement of Agreed Facts, I will read the following:

1. The Appellant is a Canadian resident who resides at 5254 Charnwood Crescent, Mississauga, Ontario, L5M 2J9.

2. The Appellant's educational and occupational background is in the municipal engineering field. He has worked exclusively in this area for over twenty-five years.

3. In 1968, the Appellant commenced employment with G.M. Sernas & Associates Ltd., (the "Corporation") as a Junior Construction Technician.

4. During the period between March of 1980 and August of 1988, the Appellant purchased 2,360 shares (the "Shares) of the Corporation at a total cost of $73,500.

5. In July of 1990, the Appellant resigned as an employee of the Corporation. As a result, according to the existing shareholders' agreement, he was required to sell the Shares to the remaining employees.

6. On or about July 11, 1990, the Appellant disposed of 2,360 shares of the Corporation.

7. The disposition was made to six employees of the Corporation, five of whom each paid the Appellant $66,000.00, and one of whom paid the Appellant $156,750.00, resulting in total proceeds of disposition of $486,750.00 paid to the Appellant.

8. The Appellant's adjusted cost base in relation to disposition was $73,500.00.

9. The Appellant had a capital gain of $413,250.00 and a taxable capital gain of $309,937.50 as a result of the disposition.

10. The Appellant used most of the proceeds from the disposition of the Shares to invest in and acquire shares in Urban Ecosystems International Inc., a predecessor to Urban Ecosystems Limited.

11. The Appellant is currently a shareholder of Urban Ecosystems Limited, which is a corporation specializing in engineering.

12. By Notice of Reassessment dated April 11, 1994, (the "Reassessment") the Minister of National Revenue (the "Minister") added the amount of $309,937 to the Appellant's taxable income for his 1990 taxation year, calculated as follows:

Proceeds of Disposition of the Shares $486,750

Less: Adjusted Cost Base 73,500

Capital Gain 413,250

Taxable Capital Gain $309,937

13. The Minister also levied a penalty against the Appellant pursuant to subsection 163(2) of the Income Tax Act, in the amount of $74,739.22.

14. At all relevant times, the Corporation was a "small business corporation" as defined by section 248 of the Income Tax Act.

15. The Shares were "qualified small business corporation shares" as defined by subsection 110.6(1) of the Income Tax Act.

16. At the time of the disposition of the Shares, the Appellant became aware of the enhanced capital gains deduction for gains realized on the disposition of qualified small business corporation shares.

17. The Appellant did not report the disposition of the shares, nor the resultant capital gain in his return of income for the 1990 taxation year. ... [Attached to the Statement of Agreed Facts is the Appellant's return of income for the 1990 taxation year. I will not go into that at this time.]

18. The Appellant filed a Notice of Objection dated June 30, 1994 to the Reassessment.

19. The Reassessment was confirmed by a Notification of Confirmation dated January 27, 1995.

ISSUES

[2] The issues before this Court have been defined as: did the Appellant, knowingly or under circumstances amounting to gross negligence, make an omission in his 1990 tax return pursuant to subsection 110.6(6) of the Income Tax Act resulting in the Appellant being to the enhanced capital gains deduction pursuant to subsection 110.6(2.1) of the Income Tax Act? And the second issue: did the Appellant, knowingly or under circumstances amounting to gross negligence, make an omission in his 1990 tax return justifying the imposition of a penalty pursuant to subsection 163(2) of the Income Tax Act?

THE APPELLANT'S POSITION

[3] The Appellant's basic position before the Court is taken from the Venne v. The Queen, 84 DTC 6247 (F.C.T.D.) case wherein Justice Strayer stated at page 6256:

"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.

[4] The Appellant 's counsel goes on to argue [in the Summary of Appellant's Legal Argument]:

The Appellant misunderstood his obligations required pursuant to the Income Tax Act, but correctly concluded that the gain would be entirely exempt. Although he did not follow the proper procedure, the bottom line is that the gain was indeed exempt and the Appellant had no economic or tax reason to hide the gain. The Appellant has not used his capital gains exemption prior to 1990, nor had he realized any capital gains in the past. Furthermore, he has not realized any capital gains since 1990. There is absolutely no reason whatsoever for the Appellant to hide this gain. He made an honest mistake and did not act in circumstances amounting to gross negligence.

THE RESPONDENT'S POSITION

[5] The Respondent's position [in the Notes of Argument of the Respondent] is simply that:

22. ... the issues raised by this appeal are issues of fact to be determined by all of the circumstances.

...

23. There is an element of subjectivity in determining whether an individual taxpayer has knowingly or through gross negligence made an omission in reporting his income.

...

24. "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.

...

[6] And based on that, the Minister concludes the Appellant's failure to report the capital gain of $413,250.00 in the circumstances did amount to gross negligence.

THE LEGISLATION

[7] The legislation involved includes, as I have indicated, subsection 110.6(2.1). That allows an enhanced capital gains deduction for $500,000.00, taxable capital gains of $375,000.00 of capital gains on qualified small business shares.

[8] Subsection 110.6(6) requires that taxpayers report capital gains realized in the year in order to receive the deduction under subsection 110.6(2.1).

[9] Under subsection 110.6(2.1), the deduction contains a lifetime limit of $500,000.00 of capital gain.

[10] The relevant portions of subsection 110.6(6) is:

Failure to report 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:

...

(b) fails to report the capital gain in his 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 his 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.

[11] In addition, we have, as indicated, subsection 163(2). This imposes a penalty on taxpayers who, knowingly or under circumstances amounting to gross negligence, make false statements or omissions in their return.

[12] As I have indicated, the focus of this case is on the question of gross negligence, and I will review at this time my appraisal of what principles govern in this case in terms of gross negligence.

[13] Gross negligence is more than mere inadvertence. It must amount to very great negligence.

[14] When you compare this to ordinary negligence, it means negligence that is easy to explain in the same circumstances. It is a matter of poor oversight.

[15] Gross negligence involves greater neglect than simply a failure to use reasonable care. It involves a high degree of negligence tantamount to intentional acting, or as being reviewed in the Venne case, an indifference as to whether the law has been complied with or not. The test for gross negligence is a subjective test.

[16] Justice Strayer in Venne noted that in most of the cases, there is an element of subjectivity with respect to assessing the gross negligence of a taxpayer for false statements in his return.

[17] And it is from that that we must look at all the factors involved in the circumstances. And, of course, one of the factors that is a paramount factor is the amount of the discrepancy. How large is the discrepancy? The second factor that is of importance is the degree of the taxpayer's reliance on advisors.

[18] There is also some case law to the effect that co-operation with investigators during an audit and voluntary disclosures have been found to be mitigating factors in the finding of ordinary negligence rather than gross negligence.

[19] Further, wilful blindness or a lack of care by someone capable of acting in a responsible manner has been found in circumstances to be gross negligence. Deliberate failure to make enquiries as to fiscal responsibilities has been found in one case to constitute gross negligence, and that case is Holley v. M.N.R., 89 DTC 366. That was Judge Kempo of this Court.

[20] Now, in relation to how the Court is to deal with these penal provisions, I think I must review this. It was not alluded to by counsel, but I think I must review this. It is very important.

[21] Penal provisions warrant strict construction, and it has been widely accepted that subsection 163(2) is a penal provision. If there is doubt as to the type of conduct to which the false statement is attributable, the benefit of the doubt should be given to the taxpayer.

[22] Judge Bowman of this Court in a case called Farm Business Consultants Inc. v. The Queen, 95 DTC 200 cited a case, Udell v. M.N.R., 70 DTC 6019 at page 6025, and I am going to read that citation:

There is no doubt that section 56(2), [now 163(2)] is a penal section. In construing a penal section there is the unimpeachable authority of Lord Esher in Tuck & Sons v. Priester, (1887) 19 Q.B.D. 629, to the effect that if the words of a penal section are capable of an interpretation that would, and one that would not, inflict the penalty, the latter must prevail. He said at page 638:

We must be very careful in construing that section because it imposes a penalty. If there is a reasonable interpretation which will avoid the penalty in any particular case, we must adopt that construction.

and at page 6026:

I take it to be a clear rule of construction that in the imposition of a tax or a duty, and still more of a penalty if there be any fair and reasonable doubt the statute is to be construed so as to give the party sought to be charged the benefit of the doubt.

ANALYSIS

[23] So it is with this background I proceeded to the analysis of this case.

[24] The taxpayer was the chief witness for the Respondent. He stated the tax return was prepared by himself for the year in question, and he stated that he also did his own returns for many years preceding. He stated he knew of the disposition, but he believed that the capital gain was tax exempt; that is, in his terminology, there would be no tax consequences.

[25] He said he received tax advice from the president of the company of the shares he was selling and the auditor of the same company, namely, a Mr. Sernas and a Mr. Berger. He said Mr. Sernas told him the $500,000.00 was tax exempt. He also said Mr. Berger indicated to him there were no tax consequences.

[26] As to the taxpayer's background, the taxpayer did not have a history of share dispositions prior to this disposition, and in relation to the transaction itself, at the time of reporting, as a consequence of his tax conclusion, he said he did not believe that he had an obligation to report the gain, because it was within the tax exempt limits. Because of this experience and experiences he has gone through relating to this case, he states now that he uses an accountant to prepare his tax return.

[27] His educational background includes high school and one year of university in Sweden. He works, as indicated from the Statement of Agreed Facts, in a municipal engineering industry. It is clear though from the evidence, he had no formal training in tax law. The proceeds of the sales, as indicated from the Statement of Agreed Facts, related to buying an interest in the new company. He also indicated in his evidence, part of the proceeds went to paying off the mortgage on his home.

[28] He fully admits his mistake in not reporting the share disposition, and he states he co-operated fully with the officials from Revenue Canada in their investigation of the matter, including the tracing of all documentation.

[29] In conclusion, his evidence was he thought he did everything he had to do. He said it was an honest mistake, and there was no intention to mislead.

[30] The second Respondent's witness was a Revenue Canada Appeal's Officer. He stated the Appellant, in an interview with him, did not tell him the sources of his tax treatment information.

[31] The Appellant, in his evidence in-chief, stated that he told the Appeal's Officer the source of his tax treatment information.

[32] This is a matter of evidence conflict. However, on this case — as a matter of credibility — and on the point of how I should assess the witnesses, I found this conflict of evidence to be very insignificant. It had no significance in my assessment of the evidence.

[33] I found the Appellant to be a straight-forward, credible witness who mistakenly thought he did not have to report the share gain disposition because he concluded, from the advice he received from his associates in the other company, that the capital gain would be exempt from tax and did not have to be reported.

[34] It is clear, the Appellant did not understand the whole basis and the need to report that is fundamental to the self-reporting tax system that applies to taxpayers in this country. And while he did his own return, beyond the advice that he did receive, he did not seek the assistance of the Revenue Canada Tax Guide as to how the gain should have been dealt with. But I did conclude he did receive some advice, albeit not good, or not fully complete.

[35] Notwithstanding this finding, I conclude from the evidence he was not attempting to deceive Revenue Canada. His mistaken belief was an honest held belief, and from that point of view, there was no economic consequence for him to hide the gain. Albeit, this also was a mistaken view because from Revenue Canada's point of view he still had available the enhanced capital gain deduction. This economic gain would only be if the Appellant attempted to use this unused enhanced capital gain deduction in a future disposition. But from his evidence, and my assessment of the Appellant, this was not, nor is it now - from what I conclude from his evidence - his intent.

[36] The amount of the omission is large, that is true. The failure to report is an indicia of negligence, I agree with that, but I cannot conclude that the action of the Appellant was to be a point of indifference as to whether the law was complied with or not. He believed he was complying with the law.

CONCLUSION

[37] I conclude from all the circumstances presented to the Court the Appellant was not grossly negligent in his failure to report the capital gain of $413,250.00.

DECISION

[38] The decision is, therefore, that the appeal is allowed and referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that the Appellant was not grossly negligent in his failure to report the capital gain. The Appellant is entitled to his costs.

Signed at Ottawa, Canada, this 3rd day of January 1998.

"D. Hamlyn"

J.T.C.C.