REASONS
FOR JUDGMENT
Smith J.
I. Introduction
[1]
Young‑Soo Kim and Ok Cha Kim (the
“Appellants”) appeal from Notices of Reassessment in respect of the 2010 and
2011 taxation years. This matter was heard on common evidence under the
informal rules on May 31, 2016.
[2]
The first issue is whether the Minister of
National Revenue (the “Minister”) correctly reassessed the Appellants for
additional net business income in the amounts of $30,342 and $25,584 for the 2010
and 2011 taxation years, respectively. The second issue is whether the Minister
was entitled to assess gross negligence penalties pursuant to subsection 163(2)
of the Income Tax Act, R.S.C., 1985, c. 1 (5th Supp.), as amended (the
“Act”).
[3]
For reasons set out below, the appeals are
allowed and the reassessments are referred back to the Minister for
reconsideration and reassessment on the basis that each Appellant had
additional net business income of $14,045 and $6,727 for the 2010 and 2011
taxation years, respectively, with gross negligence penalties to be calculated
accordingly.
II. Background
[4]
The Appellants are spouses of one another. Only
Young‑Soo Kim (“Mr. Kim”) testified at the hearing. At all material
times, they were equal partners in a laundry and dry‑cleaners business
(the “business”) located in Mississauga, Ontario.
[5]
The Appellants filed their personal tax returns
reporting income from various sources as well as their share of the net
business income calculated as follows:
|
2010
|
2011
|
Gross Sales
|
$55,701
|
$49,327
|
Expenses
|
$45,830
|
$45,961
|
Net business income
|
|
|
[6]
Mr. Kim reported total income from all
sources of $11,659 and $27,123 for the 2010 and 2011 taxation years,
respectively, and Ok Cha Kim reported total income of $11,844 and $11,695, for
the 2010 and 2011 taxation years, respectively. This included their respective
share of the net business income noted above and represented total combined
income of $23,503 and $38,818 for the 2010 and 2011 taxation years,
respectively.
[7]
The Minister assumed, for the purposes of the
reassessment, that the Appellant’s income for the subject years was not
commensurate with their personal lifestyle.
[8]
During the audit stage, the Minister requested
that the Appellants provide a budget of their annual personal expenditures and
on the basis of the information provided (and on the basis of statistical data
from Statistics Canada, as explained below), the Minister prepared the
following Summary of Personal Expenditures (“SPE”) for the subject taxation years
(Schedule 4 to the Reply):
Summary of personal expenditures
|
Dec. 31, 2010
|
Dec. 31, 2011
|
Food
|
8,689
|
8,942
|
Shelter
|
11,291
|
11,918
|
Household operations
|
3,172
|
3,195
|
Clothing
|
2,804
|
2,886
|
Transportation
|
4,417
|
4,417
|
Health care
|
4,106
|
3,909
|
Personal care
|
120
|
120
|
Tobacco and alcohol
|
-
|
923
|
Security
|
3,692
|
13,540
|
Gifts &
contributions
|
2,275
|
4,295
|
Miscellaneous
|
1,540
|
1,540
|
|
42,106
|
55,685
|
[9]
The Minister assumed for the purpose of the
reassessment, that this reflected an accurate statement of the Appellants’
annual personal expenditures. Since the total income reported by the Appellants
was insufficient to cover those expenditures, the Minister conducted a net
worth and bank audit analysis following which it was concluded that the
Appellants’ net worth had increased by $11,177 in 2010 and by a further $4,804
in 2011.
[10]
On the basis of the net worth calculation and
taking into consideration the assumed personal expenditures as well as the
total income reported, as noted above, the Minister concluded that the
Appellants had failed to report additional business income, calculated as
follows:
Description:
|
2010
|
2011
|
Assets
|
$424,653
|
$422,588
|
Less: Liabilities
|
259,377
|
252,508
|
Net Worth
|
165,276
|
170,080
|
Less: Net Worth of Prior Year
|
154,100
|
165,276
|
Increase in Net Worth
|
11,176
|
4,804
|
Add: Personal Expenses
|
42,106
|
55,685
|
Add: Other expenses
|
563
|
3,914
|
Less: Total Income Reported
|
23,503
|
38,818
|
|
|
|
[11]
The reassessment was also based on Mr. Kim’s
admission that he was the registered owner of a condominium property located in
Mississauga, Ontario and that he had received, but not declared, rent of $1,075
per month from July to December 2011. According the Minister, this amount was
incorporated in the net worth calculation noted above.
[12]
Finally, the Minister assumed that the
Appellants’ had not received any gifts, inheritances or lottery winnings during
the subject years.
III. Position of the Parties
A. Position of the Appellants
[13]
As indicated above, Mr. Kim testified at
the hearing but his spouse did not.
[14]
He took the position that the SPE was grossly
exaggerated and took offence with the fact that it included amounts that had
not been listed in the summary prepared by him and submitted to the Minister.
He produced copies of a fax forwarded to the Minister on January 25, 2016
and again on February 17, 2016 (to which he claims to have not received a
response) requesting that a detailed explanation be provided as to why the
amounts listed in the Minister’s SPE differed from his own. Attached to that
document was a hand‑written summary of his personal expenditures that
totalled $28,378 for 2010 and $28,141 for 2011.
[15]
Mr. Kim objected to the fact that the Minister
had included an amount for “food” when he had indicated nil. He suggested there
were errors in that for one year there was a nil amount for alcohol and tobacco
and $943 for the following year. An annual amount had also been included for
clothing when he had included none. He felt that other adjustments were
unwarranted but did not produce any statements, receipts or other documentary
evidence for the Court.
[16]
Mr. Kim admitted that as a result of an
error made by him in his initial summary for 2010, the amount described under
the category of “Security” should be reduced to $1,440 (and the Minister
admitted that a corresponding error had been made for the 2011 calendar year
which required a similar downward adjustment).
[17]
Mr. Kim disputed the net worth and bank
analysis summary and challenged the Minister’s ability to extrapolate from
those number that he had somehow under-reported his business income. He
explained that any shortfall in his family cash flow during the subject years
was absorbed by their personal line of credit that had increased by $35,249 in
2010 (that amount was reflected in the Minister’s assumptions). According to
Mr. Kim, those funds were used to cover his personal expenditures.
[18]
Mr. Kim acknowledged that he had not
reported rental payments from his condominium totalling $6,450 for the 2011 calendar
year but offered no explanation as to why that was so. He did not produce a
lease agreement, rental ledger, or any other form of documentation in this
regard.
[19]
He indicated that he had purchased the
condominium property in 1987 and that his mother‑in‑law had
occupied it. She had since passed away but he could not recall in what year.
When asked if he had received any gifts, inheritances or lottery winnings
during the subject years, he recalled receiving approximately $10,000 from his
mother‑in‑law’s estate but could not provide specific details,
concluding upon reflection that it pre-dated the taxation years under review.
[20]
And finally, in his closing remarks, Mr. Kim
insisted that there was no evidence that he had under‑reported his net
business income for the subject years or that he had not reported cash
generated from the business.
B. Position
of the Respondent
[21]
Josephine Datu testified on behalf of the
Minister. She completed a Bachelor in Business Administration and worked for
Agriculture Canada before joining the Canada Revenue Agency (“CRA”) fifteen
years ago. She informed the Court that she had completed the CRA audit of the
Appellants.
[22]
She explained that the audit began as a result
of a GST investigation. She had communicated with Mr. Kim and met him to
discuss his business activities. She noted that the books and records for the
business were inadequate and unreliable. She also noted that there were
discrepancies between the cash balances reported and the bank deposits. When
she questioned Mr. Kim, he indicated that he had used some cash generated
from the business to pay expenses. She concluded that the cash from the
business was not being fully reported.
[23]
Ms. Datu indicated that she provided the
Appellants with a blank personal expenditure worksheet which they completed.
The first estimate submitted during the audit stage indicated personal family
expenditures of $9,352 for 2010 and $8,329 for 2011. Since the amounts were
very low and the form was incomplete, she turned to statistical data from
Statistics Canada (for a family of three, since their son also lived with
them). For example, since the Appellants had indicated nil for the “food”
category, she inputted $8,688 for the calendar year, indicating that this was a
very conservative amount for a family of three. For restaurants, the Appellants
had either indicated $300 or nil but she used $2,200 per year based on
Statistics Canada data. She did the same for other categories including the
clothing category (for both Mr. Kim, his spouse and son) since it had been
left blank for the 2 years in question. Other amounts, notably charitable
donations, were completed using the Appellants’ personal tax return.
[24]
Ms. Datu admitted that there were errors
relating to the category of “Security”, as identified by Mr. Kim, and
agreed that an adjustment was in order. However, she indicated that this error
had arisen as a result of figures provided by Mr. Kim in his initial
summary.
[25]
She explained to the court that on the basis of
her observation that the cash receipts from the business had not been fully
recorded, she conducted a net worth and bank analysis. She acknowledged that
the Appellant’s line of credit had increased by about $35,249 in 2010 but
explained that since there was a lack of documentation as to the actual use of
those funds, she could not conclude that it was used to pay for personal
expenditures, explaining that it could have been used to improve his other
properties which included the condominium as well as a cottage. No supporting
documentation, including monthly statements, was provided by the Appellants
despite repeated requests. In the end, she concluded that the increase in the
Appellants’ net worth was either attributable to the unreported cash from the
laundry business or undeclared rent from the condominium.
[26]
In closing submissions, the Minister argued that
the Appellants had failed to discharge the onus of demonstrating to the Court
that the reassessments for the subject years were incorrect, even after taking
into consideration the errors noted above. The Minister argued that, given the
indication that cash was being under-reported and the Appellants’ own admission
that rental income had not been reported, she was entitled to proceed with an
arbitrary assessment.
[27]
In the end, the Minister argued that it boiled
down to an issue of credibility and, faced with an admission that rental income
had not been reported and the general lack of documentation, the Appellants’
version of the facts was not credible.
[28]
Finally, the Minister argued that in failing to
report the additional business income (which included the unreported rental
income), the Appellants had knowingly participated in or acquiesced in the
making of false statements or omissions in their income tax returns for the
subject years, and that this was an appropriate case for gross negligence
penalties under subsection 163(2) of the Act.
IV. The Law and Analysis
A. Arbitrary
assessment
[29]
The Federal Court of Appeal has indicated in the
decision of Hsu v. Canada, 2001 FCA 240, that the Minister may make an
arbitrary assessment using any method appropriate in the circumstances. As
indicated by the Court:
22 Subsection 152(7) of the Act empowers the Minister to
issue "arbitrary" assessments using any method that is appropriate in
the circumstances. That subsection reads thus:
152(7) Assessment not dependent on return or information.
The Minister is not bound by a return or information supplied by or on behalf
of a taxpayer and, in making an assessment, may, notwithstanding a return or
information so supplied or if no return has been filed, assess the tax
payable under this Part.
|
152(7) Cotisation
indépen‑ dante de la déclaration ou des renseignements fournis. Le
ministre n'est pas lié par les déclarations ou renseigne‑ ments fournis
par un contribuable ou de sa part et, lors de l'établissement d'une
cotisation, il peut, indépendam‑ ment de la déclaration ou des
renseignements ainsi fournis ou de l'absence de déclaration, fixer l'impôt à
payer en vertu de la présente partie.
|
Subsection 152(8) grants a presumption of validity to these assessments
and places the initial onus upon the taxpayer to disprove the state of affairs
assumed by the Minister (Dezura v. M.N.R. (1947), 3 D.T.C. 1101 at 1102
(Ex. Ct.)). Notwithstanding the fact that such an assessment is
"arbitrary", the Minister is obliged to disclose the precise basis
upon which it has been formulated (Johnston v. M.N.R. (1948), 3 D.T.C.
1182 at 1183 (S.C.C.)). Otherwise, the taxpayer would be unable to discharge
his or her initial onus of demolishing the "exact assumptions made by the
Minister but no more" (Hickman Motors Ltd. v. The Queen (1997), 97
D.T.C. 5363 at 5376 (S.C.C.)).
23 Subsection
152(7) of the Act does not establish a specific method for determining the tax
payable by a taxpayer. In most cases, the Minister follows the “net worth
method”. The Taxpayers Operations Manual prepared by National Revenue describes
the net worth method as follows:
The use of a net worth approach to
major income is based on the premise that a client's income for a period is the
increase in the client's net worth (financial position) between the beginning
and end of a particular period. A client's net worth is the excess of his total
assets, business and personal, over his total liabilities, business and
personal, at a specific date.
24 Simply put, the amount by which
the taxpayer's net worth increases over a particular period is imputed to the
taxpayer as income.
[30]
It is acknowledged that the net worth assessment
is arbitrary in nature but it reflects the fact that the Canadian income tax
system is based on self‑assessing and self‑reporting. As further
indicated in Hsu v. Canada, supra:
30 By
its very nature, a net worth assessment is an arbitrary and imprecise
approximation of a taxpayer's income. Any perceived unfairness relating to this
type of assessment is resolved by recognizing that the taxpayer is in the best
position to know his or her own taxable income. Where the factual basis of
the Minister's estimation is inaccurate, it should be a simple matter for the
taxpayer to correct the Minister's error to the satisfaction of the Court.
[My
emphasis.]
[31]
A taxpayer cannot simply argue that the
Minister’s assumptions are wrong, he must demonstrate that by providing
supporting documentation. In the absence of such documentation, the only issue
before the Court is whether the Minister’s assessment “was reasonable and
logical in the circumstances…”: Hsu v. Canada, supra, at
paragraph 33. I note that this meshes with the notion set out in
subsection 152(8) that there is a presumption as to the validity of the
reassessments:
152(8) Assessment
deemed valid and binding — An assessment
shall, subject to being varied or vacated on an objection or appeal under this
Part and subject to a reassessment, be deemed to be valid and binding
notwithstanding any error, defect or omission in the assessment or in any
proceeding under this Act relating thereto.
[32]
Where the Minister has disclosed the precise
basis upon which the reassessment has been made, the taxpayer has the onus of
providing another reliable calculation method that is both credible and
supported by evidence. In this instance, the Minister has clearly disclosed the
methodology used to conclude that the Appellants had additional unreported
business income for the taxation years in question.
[33]
The Appellants have advanced the argument that
their personal expenditures were paid using the line of credit and it was
apparent from the Minister’s assumptions that the line of credit had indeed
increased substantially in 2010. The Appellants’ argument therefore appears, at
first blush at least, to have some merit when one considers that the combined
personal income declared for the subject years, together with the unreported
rental income and increase in the line of credit adds up to about $101,396,
calculated as follows:
|
2010
|
2011
|
Total
|
Reported income Tax
Young‑Soo Kim
|
$11,659
|
$27,123
|
$38,782
|
Reported income Tax
Ok Cha Kim
|
$11,844
|
$11,695
|
$23,539
|
Unreported rental income
|
$0
|
$6,450
|
$6,450
|
Increase in line of credit
|
$35,249
|
$(2624)
|
$32,625
|
Total
|
|
|
|
[34]
Based on that analysis, there would be more than
enough cash flow within the family unit to cover the expenditures as compiled
in the Minister’s SPE. But the Appellants ask the Court to believe their
version of the facts without providing any supporting documentation. Even if
the Court considers the Appellants’ argument as to the use of the line of
credit and accepts that it is plausible, in the absence of corroborating
documentation, the question is whether it is credible, all things considered.
[35]
I am of the view that Mr. Kim’s testimony
was a mixture of bluster and bravado. It was simply not credible. Rather than
assisting the Court with a careful review of books and records or bank
statements, he preferred the offensive, challenging every number on the
Minister’s SPE. This was all the more surprising in that his initial estimate
of the personal expenditures had increased from $9,352 to $28,378 for 2010 and
from $8,329 to $28,141 in 2011. In other words, his initial estimate had
increased almost threefold and he had still not included an amount for “food”,
despite the fact (I take judicial notice of this) that it is represents one of
the largest expenditures in the average family budget. While I appreciate that
Mr. Kim may not have had full control of the family budget, he did have an
obligation to make further enquiries and his spouse, who chose not to testify,
had an obligation to participate in the preparation of the SPE. I am inclined
to believe that she was not involved but that does not assist Mr. Kim with
the issue of credibility.
[36]
Moreover, having admitted to the CRA auditor
that he had used the cash from the business to pay expenses, he proceeded to
deny that there was any unreported cash and, in another display of bravado,
invited the Government of Canada to purchase his business. He failed to produce
sales records, bank deposits or any other form of books and records such that
the Court is compelled to conclude that none existed. There was not a scintilla
of documentary evidence before the Court.
[37]
On the issue of the rental income, his testimony
was evasive at best. He admitted to unreported rental income of $1,075 per
month from July to December 2011 but failed to fill in the obvious gap with
respect to the previous six months. He provided little if any information as to
the rental history of the property from the date of acquisition in 1987,
suggesting only that it had been occupied by his mother‑in‑law. No
details were provided as to the duration of her occupancy or whether she paid
any rent although the implicit suggestion was that she had not. He could not
recall the date of her passing. Although not relevant for the purposes of this
litigation, Mr. Kim was careful and tight‑lipped as to the status of
the property after the taxation years in question. This does not help his
credibility.
[38]
As indicated above, the argument that the line
of credit was used to pay for personal expenditures during the subject years is
plausible and appears to have some merit. Faced with an arbitrary assessment by
the Minister, it represents the Appellants’ attempt to provide an alternative
or modified method to explain the unreported income for the taxation years in
question. However, it was only once Mr. Kim realized or was prepared to
admit that his personal expenditures were much higher than he had initially
estimated during the audit stage, that this argument was put forward. The Court
is unable to come to any conclusion as to whether it is an accurate statement
of the facts since Mr. Kim has chosen not to provide any evidence. Had he
been more forthcoming with details and documentation, the Court might have come
to another conclusion.
[39]
The Appellants have the onus of refuting and
demolishing the assumptions on which the reassessment is based: Hickman
Motors Ltd. v. Canada, [1997] 2 S.C.R. 336. I am of the view that they
have failed to do so.
[40]
Before concluding on this issue, I note that the
Minister’s evidence was that it was not possible to reconcile the cash balances
with the bank deposits for the business and that the books and records
maintained by the Appellants were both inadequate and unreliable. The
Appellants have a statutory obligation to maintain proper books and records as
provided for in subsection 230(1) of the Act:
230(1) Records
and books — Every person carrying on business
and every person who is required, by or pursuant to this Act, to pay or collect
taxes or other amounts shall keep records and books of account (including an
annual inventory kept in prescribed manner) at the person’s place of business
or residence in Canada or at such other place as may be designated by the
Minister, in such form and containing such information as will enable the taxes
payable under this Act or the taxes or other amounts that should have been
deducted, withheld or collected to be determined.
[41]
The absence of such records is another factor
that leads the Court to the conclusion that the version of facts put forward by
the Appellants is simply not credible.
[42]
The Court therefore concludes that the Minister
has properly reassessed the Appellants for additional unreported business
income for the taxation years in question. Taking into consideration the
adjustments to the SPE noted above (notably to the “Security” category), I find
that the Appellants had total additional unreported net business income of
$28,090 and $13,454 for the 2010 and 2011 taxation years, respectively and
consequently, that each Appellant had additional unreported income of $14,045
and $6,727 for the 2010 and 2011 taxation year, respectively.
B. Gross
negligence penalties
[43]
Having reached the conclusion noted above, I now
turn to the issue of whether the Minister was correct to assess gross
negligence penalties pursuant to subsection 163(2) of the Act. It provides
as follows:
163(2) False statements or omissions —
Every person who, knowingly, or under circumstances amounting to gross
negligence, has made or has participated in, assented to or acquiesced in the
making of, a false statement or omission in a return, form, certificate,
statement or answer (in this section referred to as a “return”) filed or made
in respect of a taxation year for the purposes of this Act, is liable to a
penalty of the greater of $100 and 50% of the total of (…)
[44]
Pursuant to subsection 163(3), the “burden
of establishing the facts justifying the assessment of the penalty is on the
Minister”. The Minister must prove (1) that the Appellants made a false
statement or omission in their income tax returns, and (2) that the
statement of omission was either made knowingly, or under circumstances
amounting to gross negligence.
[45]
The leading case on the definition of gross
negligence is Venne v. The Queen, 84 DTC 6247 (FCTD), at page 6256,
where Strayer J. stated that:
“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.
[46]
As indicated above, the absence of proper books
and records and the evidence that the cash receipts were under-reported, leads
the Court to conclude that the Appellants had no real intention of reporting
their actual income from the business – not that they simply failed to do
so. Moreover, it is not disputed that Mr. Kim failed to report rental
income in 2011. I find that the conduct of the Appellants involved “greater
neglect than simply a failure to use reasonable care” and that it involved “a
high degree of negligence tantamount to intentional acting” or “an indifference
as to as to whether the law is complied with or not”: Venne, supra.
[47]
Although the Appellants have not admitted the
unreported additional net business income assessed by the Minister, I have
already concluded that they have failed to demolish the assumptions on which
the Minister relied to determine the unreported income, and that they have
failed to provide a credible alternative or modified method of determining
their business income or to adduce acceptable evidence to support the same.
Moreover, I note that the additional unreported business income for the 2010
taxation year represents 50% of the gross sales reported ($28,090 / $55,701)
and that the amount for 2011, represents 27% of the gross sales reported
($13,454 / $49,327). These are not large amounts but the difference
is material.
[48]
I find that the Minister has satisfied his onus
with respect to the gross negligence penalties and I have no difficulty in
concluding that the Appellants have knowingly or under circumstances amounting
to gross negligence, made or participated in, assented to or acquiesced in the
making of a false statement or omission in their respective tax returns within
the meaning of subsection 163(2) of the Act.
V. Conclusion
[49]
For all the foregoing, I would refer the
reassessment back to the Minister for reconsideration and reassessment on the
basis set out in paragraph 42 above.
[50]
The Minister is entitled to gross negligence
penalties calculated accordingly.
Signed at Ottawa, Canada, this 10th day of June 2016.
“Guy Smith”