HER MAJESTY THE QUEEN,
REASONS FOR JUDGMENT
(Delivered orally from the bench on
February 17, 2015, in Toronto, Ontario.)
V.A. Miller J.
The issues in this appeal are whether the
Appellant had (a) unreported income of $23,926 and $32,211 in his 2010 and 2011
taxation years; (b) received a shareholder benefit of $13,473 in 2011; and (c)
received a management fee of $2,000 from a holding company.
The witnesses at the hearing were the Appellant,
Ed Girardi, a chartered accountant, and Indra Kukabalan, the auditor with the
Canada Revenue Agency who worked on this file.
In his 2010 and 2011 income tax returns, the
Appellant reported total income as follows:
The Appellant has been a general contractor
since 1976. He is the sole shareholder, director and officer of L.J. Post Construction
Ltd. (the “Corporation”). In 2010 and 2011, the Corporation was engaged in the
business of renovating and installing kitchens, kitchen cabinets and general
contracting. The Appellant was employed by the Corporation and he performed all
of the Corporation’s contracts. His only source of employment income was from
the Corporation. The Corporation’s fiscal year end was June 30.
In the course of conducting an audit on the
Corporation, Ms. Kukabalan noticed that there was a discrepancy between the
amount of income reported for the Corporation on its income tax returns and its
GST returns. The Corporation reported that its income in 2010 was $104,224.
Whereas, according to the GST returns which it filed for 2010, its income was $107,197.
Based on this discrepancy, she performed a sales invoice analysis in which she
reviewed all of the Corporation’s sales invoices for each year. She noticed
that these invoices were not numbered and she wasn’t sure if the Appellant had
given her all of the sales invoices.
In her initial and only interview of the
Appellant, Ms. Kukabalan stated that he told her that he charged a mark-up of
10 to 15% on materials and his labour rate was $100 to $125 hourly. Ms.
Kukabalan reviewed the sales invoices and then adjusted the material cost by
10% in accordance with the Appellant’s information. She found that there was a
significant difference between the material expense she obtained using her
analysis and the material expense claimed on the Corporation’s income tax
returns. In particular, the Corporation reported that it incurred an expense
for materials of $26,364 and $65,849 in 2010 and 2011 respectively. Whereas,
Ms. Kukabalan calculated that its material expense was $20,370.43 and
$42,311.25 in 2010 and 2011 respectively.
Ms. Kukabalan then used the invoices to
calculate the labour/material ratio for each year. She found that it was 3.69
in 2010 and 2.12 in 2011. Using these ratios, she projected the Appellant’s
income for the years at issue by multiplying the ratio by the material expense
reported in the Financial Statements reduced by 10%. However, according to Mr.
Girardi’s testimony, the amount for materials expense reported in the Financial
Statements for 2010 was not correct and for 2011, the amount included the cost
of items which were not materials. In other words, the amounts labelled
materials in the Financial Statements were incorrect.
Mr. Girardi prepared the Financial Statements
for the Corporation’s 2010 and 2011 taxation years on the basis of the
accounting records prepared by the Appellant for the Corporation. As he wrote
in the “Notice to Reader” in the Financial Statements, he did not perform an
audit of the Corporation’s records. He did not see any of the source documents
which the Appellant used to prepare his accounting records.
I have concluded from Mr. Girardi’s evidence
that the amount of $26,364.14 given for materials in the 2010 Financial
Statement was incorrect. He stated that when he was preparing the 2010
Financial Statements in order to reconcile the balance on the bank statement
for June 30, 2009 with that of June 30, 2010, he had to make an adjusting
journal entry of $2,410.09. He wasn’t sure what the amount pertained to; he did
not prepare the Financial Statements for the Corporation’s 2009 fiscal year and
he did not have access to the entries used by the former accountant to
reconcile the Corporation’s bank statement with the Appellant’s accounting
records. However, he charged the amount of $2,410.09 to materials for the Corporation’s
2010 year not knowing what this amount actually represented.
Mr. Girardi asked the Appellant to give him the
amounts for purchases which he paid in 2011 for jobs he performed in the 2010
fiscal year. The Appellant gave Mr. Girardi three amounts which totaled
$2,117.16 and Mr. Girardi recorded them as accruals. At some time prior to
this hearing, Mr. Girardi discovered that these three amounts were already
included in the materials purchases which had been given to him. Accordingly,
the accruals for this period are still missing and purchases of $2,117.16 are
In its Financial Statements for its 2011 fiscal
year, the Corporation reported that it had expenses for materials in the amount
of $65,849.06. According to Mr. Girardi, this amount is also incorrect. It
included the amount of $2,655 which was an amount paid to a subcontractor and
not an amount for materials. In addition, he reversed the accruals from the
previous year and he accrued the amount of $1,581.20 which pertained to the June
30, 2011 fiscal year but was paid in the following year. The materials amount
for the 2011 year also erroneously included the cost of a kitchen which was a
personal expense. These materials cost $13,470.
In performing her analysis, Ms. Kukabalan made
various errors. She reduced the cost of materials on the invoices by 10%; and,
she deducted PST from the cost of materials shown on the invoices. According to
Mr. Girardi, the materials expense on the Financial Statement included the PST.
Ms. Kukabalan acknowledged that in her calculations she should have deducted
the PST from the materials expense. In addition, there were invoices which did
not have a breakdown for materials and labour. Using those invoices which had a
breakdown for materials and labour, Ms. Kukabalan calculated that the ratio of
materials to labour was 1 to 3 and she applied this ratio to those contracts
which were lump sum contract. I find that her method was not arbitrary.
However, counsel for the Appellant was able to show that Ms. Kukabalan’s
calculations for some of the invoices were incorrect.
Where does that leave us? There were errors in
reporting the Corporation’s expenses. I cannot calculate its income because I
was given insufficient evidence. I note that in her audit report, Ms. Kukabalan
wrote that she believed that the Appellant and his spouse were reporting
insufficient income to support their life style. However, I heard absolutely no
evidence with respect to the Appellant’s life style.
There still remains that the Appellant’s Corporation
reported less income for income tax purposes than it did for GST purposes. The
difference was $2,973 in 2010.
The Appellant attempted to explain this
difference by stating that he received $3,468.02 from his son as reimbursement
for materials purchased on his behalf. According to him and his records, the
materials cost $3,368.02.
This does not explain the discrepancy and the
net amount for this purchase was included in the materials reported by the
Corporation in 2010 and it appears to me that this alleged reimbursement was
included in the amount for sales for 2010. The confusion in this appeal was
caused by the accounting records and Mr. Girardi’s refusal to discuss Ms.
Kukabalan’s proposal letter with her. If the discrepancy could have been explained
away so easily, why didn’t this occur prior to assessment or confirmation or
even prior to trial?
The only documents given to support the
Appellant’s evidence were his accounting records which were prepared by him. It
is self-serving evidence. As the former Chief Justice Bowman stated in VanNieuwkerk
v R 2003 TCC 670:
6….It has been
said on many occasions in this Court that accounting entries do not create
reality. They simply reflect reality. There must be an underlying reality that
exists independently of the accounting entries.
I do not accept
the Appellant’s explanation.
I agree with the submission made by counsel for
the Respondent that “the Appellant had a catch me if
you can attitude – if you find a problem I will give you an explanation and not
before”. The Appellant had heard me quote from the McKinlay
decision while he was waiting for his case to be heard. I will quote it again.
In R v McKinlay Transport,  1 S.C.R. 667, Madame Justice Wilson
The Act requires
taxpayers to file annual returns and estimate their tax payable as a result of
calculations made in these returns. … In essence, the system is a
self-reporting and self-assessing one which depends upon the honesty and
integrity of the taxpayers for its success:
Unfortunately, I know only that the Corporation
underreported its income in 2010. There was no evidence with respect to the
income reported by the Corporation in 2011 for GST purposes.
In 2010, the Corporation underreported its
income by $2,973 for income tax purposes. The Appellant is the only shareholder
in the Corporation; he controls the Corporation. I have concluded that he
appropriated this amount and it is included in his income pursuant to
subsection 15(1) of the Income Tax Act (the “ITA”).
With respect to the issue concerning unreported
income, the appeal is allowed and the reassessment is referred back to the
Minster on the basis that the Appellant underreported his income in 2010 by
only $2,973. Counsel for the Appellant was able to demonstrate that there were
errors in the auditor’s calculations and I allow the appeal of this issue for
the 2011 taxation year.
The Minister included the amount of $13,473 in
the Appellant’s income for 2011 on the basis that the Corporation paid for a
custom kitchen which was installed in the Appellant’s residence. Ms. Kukabalan
testified that she saw the invoice for the kitchen and that the materials were
delivered to the Appellant’s residence.
At the hearing, the Appellant stated that in
2011 he installed a kitchen in his son’s home and the materials cost $13,473.
He reported this cost as an expense for the Corporation. He agreed that it was
incorrectly claimed as a corporate expense but stated that he had equity in the
Corporation and thought he could claim this expense against the credit in his
shareholder loan account.
Counsel for the Appellant argued that a
bookkeeper error occurred because the amount was not debited to the Appellant’s
shareholder account which had a positive balance of $225,703 in 2011. Counsel
relied on the decisions in Chopp v R,  2 CTC 2946 (TCC); affirmed
98 DTC 6014(FCA) and Franklin v R,  4 CTC 2332 (TCC); affirmed
2002 FCA 38.
The facts in the present appeal are
distinguishable from those in Chopp. In Chopp, Mogan J. found that
there was truly an accounting error which was not discovered until Revenue
Canada audited the company. In distinguishing his decision in Chopp from
the facts in Cirillo v R,  1 CTC 2018, Justice Mogan stated
at paragraph 17 of Cirillo:
17 Was there an
accounting error in the journal entries and, if so, is the Appellant
responsible for the accounting error? Whether a shareholder of a corporation is
responsible for bookkeeping error depends upon the circumstances of the error.
In a decision that I rendered in Chopp v. R. (1995), 95 D.T.C. 527
(T.C.C.), I found that a bookkeeping error had been made without the knowledge
or intention of the dominant shareholder. I was able to make that decision
because I heard extensive evidence from four significant witnesses: the
dominant shareholder; his daughter who was an amateur bookkeeper; the outside
chartered accountant who did an actual audit of the corporation because of its
size and the corporations it did business with; and the internal chartered
accountant who was hired by the corporation after the bookkeeping error was
discovered and the dominant shareholder realized that he had to have more
competent bookkeeping. It was proven to me in Chopp that the error was
made innocently without knowledge and was corrected as soon as it was
In the present appeal, it was not established
that there was an accounting error. There was no evidence that the Appellant
told Mr. Girardi that materials in the amount of $13,473 was for a kitchen which
he installed in his son’s home and the amount should not be included in the
Corporation’s expenses. The Appellant made the bookkeeping records which Mr. Girardi
used to prepare the Financial Statements. The Appellant himself included the
amount as a purchase made by the Corporation. It had not been demonstrated that
there was a mistake or if there was a mistake that it was made innocently. The
entry has not been corrected even up to today and in my view, this confirms
that this was not simply an error.
In Franklin, Beaubier J. found that there
were a series of bookkeeping errors but the taxpayer did not receive a personal
benefit from those errors. He stated:
13 … As a result,
what has occurred is a series of bookkeeping errors in HVSL’s statements which
were caused by Mr. Franklin either on purpose or inadvertently. But none of
them gave him any benefit that is in evidence. He did not withdraw any money
from HVSL in excess of his correct loan balance during the years in question.
Nor is there any evidence that he used the incorrect financial statements to
obtain a benefit elsewhere for himself. There was no receipt of a benefit by
The facts in Franklin do not exist in the
present appeal. Here the Appellant wants to charge the amount of $13,473 to his
shareholder loan account. I note that the positive balance in the Appellant’s
shareholder loan account increased from $217,078 in 2010 to $225,703 in 2011.
No explanation was given for the increase.
At no time prior to this hearing did the
Appellant tell the CRA that the kitchen was installed in his son’s home. The
Appellant has not given any documents to support his testimony and although his
present version of the facts would not change my decision, it is my view that
the Appellant has not established that the kitchen was installed in his son’s
One of the purposes of section 15 of the ITA
is to prevent corporations from using an indirect means of conferring an
untaxed economic benefit on its shareholders: Babich v R, 2010 TCC 352
at paragraph 26. I have concluded that the Appellant received a benefit of
$13,473 in 2011.
The Appellant also owns a holding company called
Can-Holl Investments. Mr. Girardi testified that in 2011 Can-Holl Investments
reported that it had paid a management fee of $2,000 to the Corporation. At the
hearing he stated that this fee was never paid to or received by the
Corporation of the Appellant. However, in his conversation with Ms. Kukabalan
and in the notice of objection, Mr. Girardi agreed that the management fee should
be included in the Appellant’s income.
There were no documents submitted to demonstrate
that Can-Holl Investments did not pay the management fee in 2011. It is my view
that the amount of $2,000 was properly included in the Appellants income.
In conclusion, the appeal is allowed and the
reassessments are referred back to the Minister for reconsideration and
reassessment on the basis that the shareholder benefits included in the
Appellant’s income are to be reduced to the amount of $2,973 in 2010 and $15,473
Signed at Ottawa, Canada, this 14th day
of April 2016.