REASONS
FOR JUDGMENT
Visser J.
I. OVERVIEW
[1]
John David is a retired businessman living in
Bathurst, New Brunswick, and is one of approximately 19,000
individuals and corporations in Canada who were enticed into being distributors
in a pyramid scheme known as Treasure Traders International (“TTI”).
The Minister of National Revenue (the “Minister”) alleges that Mr. David
earned $21,000 of commission income from his involvement with TTI as a
distributor which he failed to report in his 2004 taxation year, and reassessed
him accordingly, together with gross negligence penalties. Mr. David
argues that he earned substantially less, and in fact incurred a loss from his
involvement in TTI when his expenses are factored in. He also argues that he
did not carry on his TTI operations personally, but that they were carried on
through his company, M.S.J Services Ltd. (“MSJ”). Mr. David has
appealed the Minister’s reassessment
to this Court.
II. ISSUES
[2]
The following issues are before the Court in
this appeal:
(a) Did the Appellant fail to report commission income relating to his
TTI operations in his 2004 taxation year?
(b) If the Appellant failed to report commission income relating to his
TTI operations in his 2004 taxation year,
(i) what was the amount thereof?
(ii) what expenses is the Appellant entitled to deduct in respect
thereof?
(iii)
is the Appellant liable to a “gross negligence” penalty pursuant to subsection 163(2) of the Income Tax Act,
R.S.C. 1985, c. 1 (5th Supp.) (the “Act”) for his failure to do so?
(iv)
could the Minister reassess the Appellant in
respect of his 2004 taxation year after the expiration of his normal
reassessment period pursuant to subsection 152(4) of the Act?
III. BACKGROUND
FACTS
[3]
The Respondent called John Glatt, an
auditor based at the London, Ontario, Tax Services Office of the Canada
Revenue Agency (the “CRA”), to testify about the operations of TTI and the audit he
conducted thereof, as well as about the specifics of the Minister’s audit and reassessment
of the Appellant in this case. I found him to be a credible witness.
[4]
Mr. Glatt testified that he was involved in
the audit of Treasure Traders International Corporation (“TTIC”)
and some of its insiders, such as Alan Kippax and some of the other senior
employees or officers of TTIC. He was also involved in the audit of many of
TTIC’s independent distributors. As part of his testimony, he reviewed some of the
documentation used by TTIC in marketing and operating the TTI program, and he
corroborated the overview of TTI set out in subparagraphs 7(a) to (k) of the
Respondent’s Reply, which I have excerpted in Schedule A hereto. As discussed
below, some of these assumptions of fact were disputed by the Appellant.
[5]
In essence, TTI was a multilevel marketing
program, often referred to as a pyramid scheme, which operated from
October 2003 to January 2006.
TTI was promulgated by TTIC and by Alan Kippax, its President and Chief
Executive Officer. TTIC was based in Mississauga, Ontario, and also had an office in
London, England. TTIC’s main business was allegedly the sale of
semi-precious coloured gemstones, such as rubies, sapphires and emeralds
(primarily emeralds). The TTI program was organized around a pirate-themed game
board called the “Treasure
Island Adventure Sales Team Game Board”
(the “Game Board”).
The positions on the Game Board included a Captain, two First Mates, four
Voyagers and eight Crew Members.
[6]
While the TTI program was complex, and there
were numerous fees potentially payable to TTIC by both retail purchasers and the
independent distributors, a key aspect of the program was the sale of places on
the Game Board by independent distributors, such as the Appellant. TTIC,
together with its distributors, would hold frequent sales meetings to sell Gem
Value Packs (“GVP”), which would entitle a buyer to be put on the Game Board. A GVP
could be sold to a buyer by a distributor as agent for TTIC for up to $1,200,
and represented a deposit (evidenced by a “Purchase Order Deposit Receipt Certificate”) on the purchase of “Gem‑Cache”, which was a gemstone set in a
laminated block with a purported value of $5,000. A buyer would also have to
pay TTIC an additional $600, for a total of $1,800, to obtain the Gem‑Cache.
Every time all eight Crew Member positions on a Game Board were filled (by
selling all eight GVPs), the Game Board would split and all participants would
move up one level.
[7]
If a distributor had the position of Captain on
the Game Board and (together with the other team members) sold all eight GVP
places on the Game Board for $1,200 each, the Captain would generate revenue of
$9,600, of which $2,600 had to be remitted to TTIC, and the balance of $7,000
was the Captain’s commission.
[8]
Mr. Glatt testified that, of the more than
19,000 independent TTI distributors, the Minister chose to only assess
distributors that the Minister believed had earned commission income equal to
or greater than $20,000.
As a result, the Minister chose to assess approximately 260 TTI distributors,
including the Appellant. In his audit of the Appellant, Mr. Glatt was
assisted by Peter S. Nicotera, a CRA auditor also based at the
London, Ontario, Tax Services Office. Mr. Nicotera did not
testify at the hearing of this matter.
IV. LAW
AND ANALYSIS
[9]
There is no dispute that Mr. David was in
some capacity involved as a distributor with TTI. The primary factual issue in
this appeal is whether Mr. David carried on his TTI operations personally
or through his company, MSJ. If I find that they were carried on by MSJ, as the
Appellant argues, the other issues raised in this appeal will become moot.
[10]
The Respondent has argued that Mr. David
carried on his TTI operations personally. As Mr. David did not provide any
documentation to the CRA when asked to do so,
the CRA reassessed Mr. David on the basis of the limited information it
had obtained from its audit of TTIC and its insiders. Based on the testimony of
Mr. Glatt and the evidence submitted by the Respondent, I note the
following with respect to the Minister’s evidence on this issue:
(a) TTIC did not cooperate with the Minister and did not comply with the
Minister’s requirement for information and documents.
(b) Mr. Glatt obtained two CDs containing TTIC financial
information from the former Chief Financial Officer (the “CFO”)
of TTIC, together with some printed information. The CFO was not called on to
testify in this matter.
(c) The TTIC financial information obtained from the CFO also contained
information on TTIC’s independent distributors, including a number of
spreadsheets, together with copies of promotional material. One spreadsheet
obtained by the Minister from the CFO was entitled “TTI Main distributor lookup.xls”, and listed the names of and contact information for 19,469 TTI
distributors. A second spreadsheet obtained by the Minister from the CFO was
entitled “Captains Paid File‑Master‑07‑28‑05.xls”,
and contained information on the timing and amounts of Captain’s Fees earned by
distributors. Neither the CDs nor the two spreadsheets were entered as evidence
in this matter.
(d) Other than the financial information set out on the CDs, the
Minister did not obtain any direct evidence showing whether it was the
Appellant personally or MSJ that was acting as a TTI distributor, and in
particular the Minister did not have a copy of the Appellant’s TTI Distributor
Agreement.
(e) With the limited exception of an excerpt from a TTI spreadsheet
relating to the Appellant’s involvement in the Moncton Fleet Port franchise, as
discussed further below, the Respondent did not enter any financial evidence
relating to the Appellant’s involvement in TTI, but rather provided limited
summaries through the CRA’s Audit Working Papers.
(f) The CRA audit working papers indicate that Mr. David was
associated with TTI ID 35725, that he was the Captain on three TTI
Game Boards which were completed in October, November and December 2004,
and that he therefore should have earned TTI commission income of $21,000.
(g) The Minister did not audit any of the bank or other records of the
Appellant or MSJ, and the Minister’s 30‑day proposal letter issued to the
Appellant was substantially based on the limited information the Minister had
obtained from the CFO relating to TTIC and its distributors.
[11]
Mr. Glatt also testified about TTIC’s Fleet
Port system, which consisted of TTIC regional offices established as
franchises, including one established in Moncton, New Brunswick. An
accounting summary submitted as evidence by the Respondent indicates that “John David” made, as a “Founder”, “deposits” dated October 28, 2004, in the amounts of $500 and
$6,500, to the TTI Moncton Fleet Port franchise. While this is evidence of the
Appellant’s purported involvement with the TTI Moncton franchise, it is my view
that it does not provide direct evidence establishing whether it was the
Appellant or MSJ that was a distributor for TTI. It is, however, consistent
with the Respondent’s position that the Appellant was personally a TTI
distributor.
[12]
Mr. David testified and presented evidence in
the hearing of this matter. He did not call any other witnesses. I found him to
be a credible witness. While he admits that he participated in TTI as a
distributor, he argues that he did so through MSJ and that, in any event, he
incurred a loss on his TTI operations, and that he was therefore personally not
required to report any TTI commission income in his 2004 taxation year. On the
basis of Mr. David’s testimony and the evidence he submitted, I note the
following with respect to the Appellant’s evidence on this issue:
(a) Mr. David was the 100% shareholder and President of MSJ, and over
approximately a 25‑year period started six different business ventures
through MSJ. In 2004, MSJ had approximately 38 employees and carried on a
general construction contracting business.
(b) In 2004, MSJ was operating at a loss, and its bank had cut its
credit line by half and was threatening to cut it further. MSJ was invited to
join TTI by a friend of Mr. David, and after Mr. David had attended
some TTI sales presentations by Alan Kippax, he was convinced that TTI
offered a prospect of long‑term profit for MSJ (just as many thousands of
other Canadians had also been convinced). In addition to becoming a TTI
distributor, MSJ joined a group of business people and bought into the Moncton
Fleet Port franchise at a cost of $7,000. A receipt was issued by TTI to MSJ
for this payment.
(c) MSJ hired two new employees and provided training to them to operate
its new business venture as a TTI distributor, and it obtained funding therefor
from Human Resources Development Canada (“HRDC”) in Bathurst, New Brunswick.
MSJ also leased and renovated additional office space in Bathurst for its TTI
operations. The Appellant had also planned to incorporate a new company
(referred to as KIS in evidence) if MSJ’s TTI operations had been successful,
with the intention of transferring the TTI business from MSJ to this new
company in due course. While the Appellant had started that process, the
transfer was never effected as TTI began to fall apart before it could occur.
(d) After approximately a month of training and development in
November 2004, MSJ and others began having difficulties with TTIC. TTIC
was not paying money owed and it changed the locks on the Moncton Fleet Port
offices and seized all of the Moncton Fleet Port assets and records.
(e) Once it became evident in late 2004 that the Appellant and MSJ had
been scammed by TTIC and that MSJ would lose its investment, MSJ ceased all TTI
operations and terminated the employment of the two employees hired to work on
its TTI operations.
(f) In 2005, MSJ lost most of its credit line and, due in part to the
embarrassment of its TTI failure and to the Appellant’s illness, the Appellant
was forced to close MSJ. In closing MSJ, the Appellant was able to ensure that
all of MSJ’s liabilities, including those with regard to subcontractors,
suppliers, employees and taxes, were paid in full.
(g) Although TTI had complex rules and procedures, it did not follow its
own rules and procedures, and changed them regularly in reaction to issues
raised by its distributors and customers. In particular, it changed its sales
rules and sold certificates to distributors in bulk for $325 because
distributors did not trust TTIC to pay commissions if the full amount of sales
flowed to TTIC.
(h) In a letter dated December 12, 2004, the Appellant wrote
to Alan Kippax at TTIC as follows:
It has come to my attention that
certificates purchased under MSJ continue to be registered under my personal
name? I have called your office earlier with no results? Can you please make
the changes and advise accordingly?
(i) The Appellant and his accountant did not receive the CRA’s 30‑day
proposal letter, dated January 21, 2009, and only became aware of this
matter upon the Appellant being reassessed by the Minister in March 2009.
(j) In a letter dated June 7, 2010, addressed to the Chief of
Appeals, Mr. David’s accountant submitted to the Minister that:
. . .
Mr. John David was the 100%
common shareholder of M.S.J. Services Ltd. (MSJ), corporation tax number . . . .
The corporation tax year in question is May 1, 2004 to
April 30, 2005 . . .
. . .
Certificates were purchased by M.S.J.
Services, as a gift for its key employees and other people who helped support
the company through some of its more difficult times. . . . We
believed so strongly in this project that three new positions were created in
MSJ and employees were hired on a subsidized program through
Anita Boudreau HRDC Bathurst NB. These employees were being trained
specifically to work on developing our interest in TTI. . . .
Additional office space was rented and renovated in Bathurst just for this
project.
. . .
MSJ was the operative with TTI and
not John David. MSJ incurred $16,333.57 . . . in expenses
including the $6,500 payment . . . to TTI for the franchise fee on
October 25, 2004 . . . .
. . .
In summary MSJ did not receive
$21,000 as assessed. MSJ paid the $325 on behalf of its employees and did not
record or require employees to pay the $1,200. M.S.J. Services Ltd and not
John David was the involved party with TTI.
(k) Attached to the accountant’s submission were copies of the following
supporting documents:
(i)
The financial statements for MSJ for the year
ended April 30, 2005, which were prepared by Allen, Paquet &
Arseneau LLP, Chartered Accountants. Mr. David indicated that the “Office”
expenses in the amount of $19,309 set out on page 3 thereof included
various expenses incurred by MSJ in respect of the TTI program.
(ii)
Excerpts from the trial balance and general ledger
of MSJ backing up the above‑referenced office expenses in the amount of
$19,309, and in particular referencing various expenses and other cash inflows
and outflows relating to TTI, such as the purchase of distributor kits for
$450, payments in the amount of $500 and $6,500 for the Moncton Fleet Port
franchise (discussed above), TTI admittance fees, a $1,200 refund to
Denis Roy (one of the TTI certificate purchasers), as well as payments for
miscellaneous items relating to TTI. These documents also reflect the wages
paid to employees who were hired for MSJ’s TTI operations, as well as the wage
reimbursement obtained from HRDC.
(iii)
A cheque dated December 27, 2004, in
the amount of $1,200 payable by MSJ, to Denis Roy in respect of a refund
of the amount paid for the TTI certificate he had purchased.
(iv)
A receipt dated November 18, 2004 from
TTI, made out to MSJ, in the amount of $7,000 for the payment of the Moncton Fleet
Port franchise fee.
(v)
A blank distributor agreement, which sets out
the various terms thereof, including section 2.3, which gives TTI the right to
change the price of the TTI certificates.
(vi)
A summary of the TTI certificates handled by
MSJ, showing a purchase price of $450 for most of the certificates. It also
indicates that TTI reduced the price of the certificates to $325 before its
collapse, and therefore that some of them were purchased from TTI for $325. The
Appellant testified that MSJ gave two certificates, as a training tool, to two
of its employees (Ginette Aubie and Trevis Branch) who were hired to
work on the TTI project. MSJ also gave TTI certificates to Claude David,
the Appellant’s brother, who regularly provided financing to the Appellant and MSJ.
One certificate was given by the Moncton TTI Fleet Port office to the Appellant
as an incentive to get him involved in that franchise. Two certificates were
given to Doug and David Sheppard (the Appellant’s sons), who were working
for MSJ. One certificate was given to Iris Sheppard, the Appellant’s
spouse, and certificates were given to Gino Degrace, Dickie Lavigne
and Jean‑Marc Lavigne, MSJ’s three foremen. One unsold certificate
was also given to MSJ’s accounting firm. None of these recipients were charged
any amount for these certificates. There were also four certificates that were
sold to individuals for $1,200 each, but the one sold to Denis Roy was
fully refunded and for one of them (sold to Gilles Caron) MSJ only
received the $875 commission portion of the sale. Overall, MSJ remitted $5,675
to TTI in respect of these certificate sales and collected net sales proceeds
of $3,275.
Mr. David also testified that he had a number of unused TTI certificates,
but that, as TTI had collapsed, he could not sell them since they were
worthless and he felt it would be illegal to do so.
(vii)
A “Captain for Life” brochure, which states
that a Captain can provide themselves with a certificate at no cost to ensure that
they are on each Game Board when it splits.
(viii)
A copy of the unsold certificate held by MSJ’s
accountant.
(ix)
Signed statements by each of Claude David,
Iris Sheppard, Doug Sheppard, David Sheppard,
Dickie Lavigne, Gino Degrace, and Jean‑Marc Lavigne confirming
that they did not pay for their TTI certificates, that payment for the certificates
was made by MSJ to TTI, and that the certificates were worthless.
(x)
Unsigned statements of Ginette Aubie and
Trevis Branch to which I gave no weight.
[13]
The signed statements are all in similar form,
and appear to have been prepared by the Appellant or MSJ. I note that the $325
amount referenced in all but one of them as being the amount paid for each of
those certificates differs from the $450 amount set out in the summary of the
TTI certificates handled by MSJ. I also note that MSJ’s financial statements and
the excerpts from the trial balance and general ledger of MSJ submitted as
evidence do not directly show the TTI revenue of $3,275 purported to have been
earned by MSJ. The Appellant testified that these sales were all in cash, that
the proceeds would have been used to pay TTIC or others for amounts owing with
respect to certificate purchases and sales, and that therefore there were no
net proceeds to be deposited into MSJ.
[14]
Mr. David submitted that MSJ was in a
substantial loss position in 2004, as shown on the company’s income statement,
and that he therefore had an incentive to carry on the TTI operations in MSJ,
as he had hoped they would generate a profit and thus improve MSJ’s
profitability. This was important because he was having issues with his
financial institution regarding the financing of the company, and improved
profitability might have helped save his company. He also submitted that, from
a tax perspective, MSJ had no reason not to report the profit, if any, from the
TTI operations as MSJ’s pre-existing losses would have offset any such income.
[15]
The Minister relied substantially on information
obtained from TTIC’s CFO in raising its reassessment of the Appellant. The CFO
had taken these records from TTIC shortly before it ceased operations in
January 2006 or thereabouts. The Appellant, however, argued that TTIC was
a corrupt organization operating an illegal pyramid scheme and that its records
should not be relied on. In support of his position, the Appellant submitted
evidence relating to TTIC, Alan Kippax and BIM, a similar pyramid scheme
operated by Alan Kippax at or about the same time as TTI. Included in this evidence was
a copy of the CRA’s position paper on income relating to TTI, which the Appellant
obtained in July 2014.
This paper indicates that the CRA “. . . decided to undertake audit activity with
respect to this organization in February of 2006 due to the existence of many
risk indicators including non-compliance with respect to filing both GST and
Income Tax (T2) returns.” The Appellant thus
argues that TTIC’s records, obtained from a third party after TTIC had ceased
operations, should not be relied on, and indeed notes that the CRA itself points
out the many risk factors associated with TTIC.
[16]
In considering the evidence presented by both
parties, I note that the Respondent relies on the references to “John David” in the spreadsheets obtained from the CFO relating to both the
certificate sales and the TTI Moncton Fleet Port franchise. As the originals or
copies of these documents were not submitted as evidence in court, and the CFO
did not testify, the Appellant did not have an opportunity to review or
directly challenge the accuracy of these documents. The Appellant argued that
TTIC’s business records, obtained from a third party, should not be considered
reliable given the nature of TTIC’s allegedly illegal operations and the
serious allegations and charges made against TTIC and Alan Kippax, as set
out in the evidence he submitted. I note that the CRA in its TTI position paper
acknowledged the significant risk factors associated with TTI. I also note that
the evidence submitted by the Appellant supports his position that MSJ carried
on his TTI operations. For example, the December 12, 2004 letter sent
to TTI requesting that TTI correct its business records to properly reflect MSJ
on the certificates corroborates his testimony and indicates that TTIC’s
business records were incorrect in referring to sales being made by “John David”. In addition, the November 18, 2004 receipt issued by
TTI to MSJ for the $7,000 franchise fee corroborates the Appellant’s testimony
and clearly contradicts the Respondent’s evidence on this issue. I also note
that the Appellant’s testimony, MSJ’s accounting records and the other
financial documentation submitted by the Appellant clearly establish that it
was the Appellant’s intention to carry on the TTI operations in MSJ, and that
they were in fact carried on in MSJ.
V. CONCLUSION
[17]
Overall, considering all of the evidence, I am
satisfied that the Appellant has clearly established that:
(a)
He carried on his TTI operations through MSJ and
did not earn any TTI commission income personally in 2004, and was therefore
not personally required to report any income or loss from the TTI operations in
his 2004 taxation year.
(b)
MSJ generated TTI revenue of $3,275 and incurred
expenses substantially in excess of that amount in relation to its TTI
operations.
(c)
MSJ included its TTI operations in its fiscal
year ended April 30, 2005.
[18]
As I have determined that the Appellant did not
personally earn any TTI commission income in 2004 and therefore did not fail to
report any such commission income, the other issues raised in this appeal are
moot.
[19]
In light of all of the foregoing, the appeal is
allowed in full, without costs.
Signed at
Ottawa, Canada, this 5th day of April 2016.
“Henry A. Visser”
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