basically the moving force of Mongos. Mongos operated
as a restaurant as well as running a catering service. It closed for
renovations from December 2002 to August 2003 to add a cigar bar and martini lounge.
[6]
The business did not
fare as well as Mr. McLeod had hoped, even after the renovations. In May 2004,
he hired Mr. Fay, an experienced chef and executive in the food and beverage
business, who suggested the business was not being run as it should. Mr.
McLeod, along with Mr. Fay determined, after a couple more years of operation,
that the business should indeed be shut down, which it was in 2006. At that
time, the assets of the business were sold to a third party for $159,000.
Audit
[7]
The Canada Revenue
Agency ("CRA") commenced its audit of Mr. McLeod and Mongos in
the summer of 2006. While there was some lengthy testimony by Mr. Axelson, the
auditor, of the audit process, I wish only to highlight the pertinent details.
It was clear that Mr. Axelson did not find the Appellants nor their advisors as
forthcoming as he would have liked.
[8]
The audit did not start
as a net worth, but a rough analysis of bank deposits of Mongos versus reported
sales. A considerable discrepancy in that regard, plus the use by the Appellant
of the shareholder loan account to record such a difference, caused the auditor
to deem Mongos’ books unreliable. He therefore proceeded to conduct a net worth
assessment of Mr. McLeod. He did, however, turn around and rely on the deemed
unreliable shareholder loan account to increase Mr. McLeod’s net worth by
over $250,000.
[9]
Mr. Axelson was not
provided with personal bank statements nor given the opportunity to interview
Mr. McLeod. I note that fairly early on, Mr. McLeod’s accountant, Mr.
Lotoski, did mention to the auditor there was a $30,000 loan owed by Mr. McLeod;
not until December 2007 was there any mention by Mr. Lotoski of any other
loan. Mr. Axelson, in the summer of 2007, sought a personal expense
questionnaire, which Mr. Lotoski testified he had provided. Mr. Axelson
never received it. Few source documents were provided. While Mr. Axelson
sent a proposal to Mr. Lotoski in December 2007, he did not get around to
close the file and reassess until August 2008.
[10]
Mr. Axelson determined
that Mr. McLeod had only one asset, being his shareholder’s loan account in
Mongos. He further determined Mr. McLeod had no liabilities, but that the
shareholder’s loan account increased by over $250,000 during the two year audit
period.
[11]
At the Appeals level,
the CRA was provided with a copy of a $30,000 cheque evidencing a loan from Ms.
Patricia Crichton, along with a one page document from Mr. T. Day, in the form
of a letter dated February 27, 2008 confirming that he had lent Mr. McLeod
$155,000 for use in Mongos.
[12]
From a review of the
net worth it is clear that the increase in the shareholder loan account from
$139,381 in January 2003 to $393,702 at the end of December 2004 was taken
at its face value by the auditor and represents almost all of the amount of
unreported revenue the Minister maintains Mongos received in 2003 and 2004. As
indicated, the shareholder loan account was the only asset appearing on the net
worth statement; no real estate, no cash, no investments, no cars, nothing
else. The net worth assessment also shows zero liabilities. The Courts have
described the net worth assessment as a blunt instrument – this is particularly
blunt.
[13]
Interestingly, the
Minister assessed Mr. McLeod as receiving a subsection 15(1) of the Act
shareholder benefit of $83,088 in 2003 and $167,749 in 2004 from Mongos. The
auditor suggested that the bank deposits to Mongos’ account were exact numbers
and therefore looked more like revenue than shareholder loans. The Minister
relies on the following assumptions in the Reply:
…
y) bank deposits to the Company’s bank account greatly
exceeded reported sales revenue in both years – by $69,596 in 2003 and $152,117
in 2004;
z) the unidentified bank deposits were unreported sales
revenue of the Company;
aa)
the Appellant under-reported the Company’s
revenues;
bb)
the Appellant provided only the purported
monthly sales total to his accountant for entry into the accounting records;
cc)
the Appellant directed that the difference
between the total revenue figure he provided to his accountant and the total
bank deposits be credited to his shareholder loan account as a contribution;
dd)
instead of crediting sales, the Appellant
appropriated the unreported revenue of the Company by crediting the amount of
the unreported sales revenue to the shareholder loan account;
ee)
thus Company sales revenue became an amount due
to the shareholder;
ff)
the Appellant appropriated from his Company for
his personal benefit the unreported business revenues identified in the net
worth review;
gg)
in 2003 and 2004, the Appellant appropriated
$83,088 and $164,749, respectively, from the Company;
hh)
the company conferred the $83,088 and $164,749
on the Appellant in his capacity as a shareholder;
…
The Minister then goes on to describe the issue as:
…
a) in 2003 and 2004, the Company conferred $83,088 and
$164,749, respectively, on the Appellant in his capacity as a shareholder; …
This does not strike me as a net worth assessment as
much as simply a subsection 15(1) of the Act shareholder
appropriation, based on Mongos recording the excess of deposits over sales, emanating
from the sales ledgers, as a shareholder’s loan. The Minister is saying these
are sales hidden in the shareholder loan account. The Minister has a
two-pronged approach set out in the Reply as follows:
14. The Appellant’s yearly changes in net worth and personal
living expenditures were as set out in Schedules I, II, III and IV. The
discrepancies between those figures and his reported incomes in those years
arose from incomes that the Appellant earned and failed to report. As such, the
Appellant earned and failed to report respective incomes of $83,088 and
$164,749 in 2003 and 2004, calculated with reference to section 3 of the Act.
15. In 2003 and 2004, the Company conferred the $83,088 and
$164,749 on the Appellant in his capacity as a shareholder. As such, those
amounts must be included in the Appellant’s income under subsection 15(1) of
the Act.
16. Alternatively, if all or part of the $83,088 and $164,749
was not appropriated from the Company in 2003 and 2004, respectively, which is
expressly denied, those amounts are unreported business income from another
source or sources that the Appellant earned and must be included in the income
of the Appellant pursuant to subsection 9(1) of the Act.
[14]
Frankly, whichever,
argument the Minister puts forward, the issue I find relates to three items:
a) did Mr. McLeod have a
liability in the form of a $155,000 loan from Mr. T. Day, funds which were
injected into Mongos forming part of the shareholder’s loan account?
b) did Mr. McLeod have a
liability in the form of a $30,000 loan from Mr. Ellis’ aunt, Ms. Crichton,
which also was part of the shareholder’s loan account?
c) was the shareholder
loan account for the period in question overstated by approximately $74,000,
which is evidenced by a 2005 accounting adjustment which I will explain
shortly?
I will deal with the facts surrounding each of these
in turn.
$155,000 loan
[15]
In late 2002, Mr.
McLeod had discussions with his friend, Mr. Tim Day, as well as with his
brother, about a new concept for the restaurant; the idea of adding an upscale
cigar bar and martini lounge. Mr. Day had several other businesses, primarily
in the printing industry, though one of which was the sale of cigars. My
impression from Mr. Day is that he dabbled in the cigar trade, admitting that
he was his best customer – he liked cigars.
[16]
Mr. Day testified that
on one occasion in supplying cigars to a bar, he was struck by the amount of
cash the bar had on hand. This left a favourable impression such that he saw a
profitable opportunity for Mr. McLeod’s expanded bar. He claimed that he
proceeded to provide Mr. McLeod funds to assist with the bar renovations.
[17]
Mr. Day described his
investment in Mongos as a loosey-goosey arrangement. The deal was Mr. Day would
be a 50/50 partner with Mr. McLeod in owning the business, yet he would wait to
see how profits went before finalizing that arrangement. Indeed, profits never
materialized to the point that Mr. Day actually became a part-owner. The
monies he says he provided to Mr. McLeod therefore remained more in the form
of a loan. Mr. Day and Mr. McLeod put nothing in writing evidencing the
arrangement other than a ledger which I will have more to say about shortly.
Mr. Day claims that as Mr. McLeod was a good friend, he was prepared to do this
on handshake basis.
[18]
Mr. Day claims that the
$155,000 was advanced in cash and that it came from a cache of money that he
had accumulated over the years and that he simply kept in cash. He maintained
he did not want to put the money in the bank, only to have to pay tax on any
interest earned. This is a somewhat peculiar concept. He believed he could turn
the cash to more profit by the purchase and sale of businesses. He identified a
few businesses in this regard.
[19]
I turn now to the
ledger proffered as the best evidence of the loan. This was in the form of a
black ledger book which only had one page of entries, titled "Loan to Stan
McLeod re: Mongos restaurant to purchase 50%". The ledger then went on to
make the following entries:
TOTAL
November
17, 2002 $20,000 $20,000
January
5, 2003 $15,000 $35,000
March
12, 2003 $ 5,000 $40,000
May
25, 2003 $10,000 $50,000
July
3, 2003 $ 5,000 $55,000
September
10, 2003 $ 5,000 $60,000
October
15, 2003 $ 5,000 $65,000
December
10, 2003 $10,000 $75,000
January
18 2004 $25,000 $100,000
February
3, 2004 $10,000 $110,000
March
15, 2004 $25,000 $135,000
May
3, 2004 $20,000 $155,000
TOTAL $155,000
After the two columns, there are also two headings for
the initials of both Mr. McLeod and Mr. Day: all entries appear to
have been initialled. It is clear that a different pen was used for different
entries. This document only came to light the week before trial. Mr. Day’s
explanation was that he left Canada and moved to Costa Rica a few years ago,
where he still lives. He came back to Canada for this first time to visit
family and friends and for this trial in early May of this year. When he left Canada, he took some records of his businesses with him and stored some with his daughter here in Canada. According to Mr. Day, only upon his recent return in going through his records
that were left in Canada did he come across this ledger.
[20]
Mr. McLeod confirmed
that he initialled this ledger, though at discovery he had stated that the
amounts received from Mr. Day were in smaller amounts of $1,000, $2,000 or
$3,000, always in cash. This is not in accord with the ledger.
[21]
A review of bank
deposits shows no major cash deposits lining up with the time of the loan advances
set out in the ledger. Mr. McLeod explained that the cash would often go
directly to the contractors and suppliers working on the restaurant
renovations. The financial statements of Mongos indicate an increase in
leasehold improvements of only approximately $81,000 over the period in
question. Mr. McLeod did suggest that some of the funds from Mr. Day may
have been used for operations, yet the restaurant was shutdown for the
renovations for approximately eight months.
[22]
With respect to the
repayment of this loan, Mr. Day testified that he received approximately
$48,000 from Mr. McLeod when Mr. McLeod sold the assets of Mongos in
2006. Further, after Mr. McLeod sold Mongos, Mr. Day asked Mr. McLeod to
do renovations for his business, OK Blue Printing, the cost of which went to
offset the loan. Mr. Day said he kept track of the cost to know when it equated
to a repayment, though he produced no records in that regard. He suggested it
was fully repaid by the summer of 2006.
[23]
Before describing Mr.
McLeod’s explanation of the repayment of the loan, it is necessary to explain
what occurred after the demise of the restaurant in 2006. Mr. McLeod was asked
by Mr. Day to join him in the printing business, as Mr. Day felt Mr.
McLeod had significant contacts in Kelowna. They incorporated a company in British Columbia in November 2006 to operate OK Blue Printing.
[24]
In June 2008, they sold
the printing business and Mr. McLeod took out his share, $223,250, as what was
described in the company’s books as a management salary. In fact, this amount,
which was actually paid to Mr. McLeod, was recorded as having been received by
Mongos (now called S and R Industries Inc.) and then out to Mr. McLeod to pay
down his shareholder’s loan.
[25]
With that background, I
now turn to Mr. McLeod’s explanation of the repayment, which seems to have gone
through a couple of transformations. At discovery, Mr. McLeod explained he
repaid the loan to Mr. Day from the $223,250 proceeds received on the sale of
his interest in the British Columbia company. On undertakings, he explained he
was working at OK Blue Printing in order to repay Mr. Day in non-monetary
terms. Then, in a letter in July 2013, he corrected that answer by indicating
that the cost of the renovation of the OK Blue Printing business, including
labour and materials, were paid by the Appellant and these were tracked and
treated by Mr. Day as a full repayment of the Appellant’s loan to Mr. Day. The
$223,250 funds received by the Appellant upon the sale of OK Blue Printing were
his share of the profits due to him as a shareholder of and provider of services to OK Blue Printing business.
[26]
Mr. McLeod’s
accountant, Mr. Lotoski, testified he was aware of the money advanced by Mr.
Day to Mr. McLeod, though it was not until some significant time into the audit
that he first raised this with CRA, notwithstanding he was handling the tax
dispute on Mr. McLeod’s behalf from the outset. The CRA audit started back in
2006.
[27]
I had the impression
there was certainly no love lost between Mr. Lotoski and the CRA
officials. Mr. Lotoski stated that when asked for a personal expense from the
CRA for Mr. McLeod, this would not necessarily require a mention of any
personal loans, yet upon filling in the personal expenditure questionnaire, he
did include such loans. This struck me as contradictory. The questionnaire was
not provided to CRA until a long time after Mr. Lotoski indicated that it had
been.
[28]
Mr. McLeod’s brother
testified briefly. I found him to be straightforward. He said that he was often
lending money to his brother so that he could survive, as he put it.
[29]
Mrs. McLeod, Mr.
McLeod’s mother, who served as bookkeeper of Mongos, also testified that she
was aware Mr. Day was helping out financially.
[30]
So, did Mr. Day lend
$155,000 to Mr. McLeod to put into Mongos. Clearly, if the entries in the
ledger of the advances were made at the times indicated from 2002 to 2004, then
this would be a significant corroboration of Mr. McLeod’s and Mr. Day’s story.
There are several factors, however, that cast suspicion on the veracity of this
document:
a) the ledger book
itself has a few pages missing before the page in question and then no other
entries at all;
b) Mr. Day appears quite
content to operate on a handshake basis with his friend yet has this detailed,
dated, one page ledger;
c) the ledger does not
accord with Mr. McLeod’s explanation of the amounts (small denominations) of
the advances – one would presume advances of $20,000 and $25,000 would be
noteworthy; and
d) this critical piece of
evidence shows up a week before trial in 2013 notwithstanding the audit started
seven years earlier and the Appellant, and certainly Mr. Lotoski, must have
appreciated the significance of obtaining evidence such as this.
[31]
The Appellant’s answer
to the suspicion cast on this document is, first, why would Mr. Day fabricate
anything as he has no personal interest in the matter; second, given Mr. Day’s
absence from the country until recently, it is perfectly plausible the document
could only recently have to come to light; and third, Mr. McLeod has
suffered concussions over the years due to an active sporting life and serving
as a bouncer and, therefore, his memory has been affected explaining the
discrepancy between his discovery evidence and the ledger. This latter reason
has only been raised at trial.
[32]
I suggested to counsel
that an expert in handwriting or ink analysis might have been helpful in
examining the document. The Respondent had considered seeking an adjournment
for that purpose but decided not to. Counsel for the Appellant indicated the
willingness on the part of the Appellant to have such an analysis done.
[33]
I am satisfied, given
Mr. Day’s interest in Mr. McLeod’s concept, especially as it relates to a cigar
bar, and given that Mr. Day had some means (though I am not convinced the means
was a $200,000 cash accumulation), and given Mrs. McLeod’s testimony,
which I find credible, that she was aware Mr. Day was helping out (though
apparently not aware of many details), that Mr. Day did provide some financial
assistance to Mr. McLeod. I have not been convinced, however, it was
necessarily $155,000. I am not prepared to rely on the recently produced one page
ledger as definitive proof of loans in the amounts indicated.
[34]
The improvements to the
restaurant which took place from January 2003 to August 2003 were shown in the
books (albeit a year later) at around $81,000. According to Mr. Day and Mr.
McLeod, $100,000 was lent after the reopening of the renovated restaurant, at a
time when, according to Mr. McLeod, business was pretty good. That did not last
long.
[35]
I am also concerned not
just with the different stories between Mr. Day and Mr. McLeod as to how the
loan was repaid, but also with Mr. McLeod’s own varying story. No, the pieces
of the $155,000 loan puzzle do not fit neatly together.
[36]
The dilemma I am faced
with is the conclusion that, yes, Mr. Day did assist Mr. McLeod, and
consequently, Mongos, financially, but then not having sufficient proof to
determine the extent of that financial assistance. I will turn to this after addressing
the $30,000 loan and the mechanics of the shareholder loan account.
$30,000 loan
[37]
Mr. Ellis, a licensed
real estate agent, was a neighbour of Mr. McLeod. Indeed, Mr. Ellis sold his
house to Mr. McLeod for approximately $400,000, but kept the property in his
own name while Mr. McLeod made monthly payments. A contract of purchase and
sale dated August 15, 2000 set out the payment arrangement. Only now, according
to Mr. McLeod, are the final payments being made to transfer legal title to
him.
[38]
Mr. Ellis claims his
aunt, Patricia Crichton, was looking to invest some money when she moved to the
Okanagan in 2002. Mr. Ellis was aware that Mr. McLeod was planning on
expanding Mongos and needing financial help. According to Mr. Ellis, Ms.
Crichton was concerned about the stability of a restaurant and the fact that
Mr. McLeod did not own the property he lived in.
[39]
In June 2003, Ms.
Crichton wrote a cheque to Mr. McLeod for $30,000. In October 2003, according
to Mr. Ellis, to address his aunt’s concerns, the following agreement was drawn
up and signed by Mr. Ellis, Mr. McLeod and Ms. Crichton:
October
31st 2003
This
Agreement is between Patricia Crichton and Stan McLeod, Patricia agrees to loan
Stan $30,000.00 towards the finishing of the garage presently under
construction at 512 Zdralek Cove in Kelowna B.C.
Stand
agrees to repay the full amount on or before April 1st 2004 along
with an interest amount of $1500.00 bringing the total to 31,500.00.
In
case of default the loan will be registered against the property 512 Zdralek
Cove which is presently owned by Shawn Ellis and will stay in his name until
the termination of this loan.
In
case of default the outstanding amount will accrue interest at a rate of 2% per
month.
This
contract is legal and binding, signed in Kelowna B.C. this 31st day
of October 2003
[40]
The agreement refers to
the money to be used for Mr. McLeod’s personal garage, not Mongos. Mr. McLeod
had taken out a building permit to build a garage in 2003 yet he insisted the
funds went to Mongos’ renovations and that he did not start work on the garage
renovations until 2004.
[41]
Mr. Ellis was confused
as to how the loan was repaid, suggesting it may have been repaid back in 2004
or perhaps that he paid his aunt and Mr. McLeod simply reimbursed him. Mr.
Lotoski, Mr. McLeod’s accountant, confirmed that Mr. Ellis did repay Ms.
Crichton. Mr. Lotoski went on to suggest that Mr. Ellis had previously
loaned Mr. McLeod $200,000 and that debt was bumped up by $30,000 so that
effectively Mr. McLeod’s debt to Ms. Crichton shifted to Mr. Ellis, which
Mr. Lotoski said was settled recently.
[42]
The agreement of
October 31, 2003 has a handwritten note purportedly from Patricia Crichton
indicating the loan was repaid in 2009.
[43]
There are two hurdles
for the Appellant to overcome to have the $30,000 loan reduce the net worth
assessment. First, it must be found to have gone to Mongos and, therefore,
increase the shareholder loan account. Only then should there be an offsetting
liability in the net worth. Secondly, it must not have been repaid until after
2004.
[44]
On the first issue,
what works against Mr. McLeod is the reference in the agreement of October to
the loan going towards the garage and not to Mongos, plus the timing of Mr.
McLeod’s obtaining a building permit. What works for Mr. McLeod is his own
testimony that he used the funds in Mongos, Mr. Ellis’ testimony that that
was what the loan was intended for, and to the best of Mr. Ellis’ knowledge
what it was used for, Mr. Ellis’ testimony that the agreement was drawn the way
it was simply to satisfy his aunt, Mr. Lotoski’s testimony the monies were needed
to pay Mongos’ supplies and contractors, and, according to Mr. McLeod, the
personal renovation (garage and cabana) was not undertaken until 2004.
[45]
Again, I reach a similar
conclusion on the $30,000 loan as with the $155,000 loan, and that is, there
was a loan, but in this case, is there sufficient proof to determine whether
all of the $30,000 went into Mongos. I had the clear impression from the
witnesses and Mr. McLeod himself, that Mr. McLeod did not have a strong
business acumen. He relied on others. His ability was more working with his
hands – construction and repairs, than the business side of running a
restaurant. The most plausible explanation is that Mr. McLeod simply took
the $30,000 and used it wherever he liked and needed funds at the time. He had
a history of borrowing. Frankly, he was not particularly well served by his
professional advisors: accounting of monies in and out of Mongos could have
been clearer.
[46]
With respect to the
second issue, I am prepared to give Mr. McLeod the benefit of the doubt and
conclude that the loan was not repaid until after 2004. This accords with Mr.
Lotoski’s explanation and Mr. Ellis’ somewhat fuzzy recollection.
Shareholder loan account
[47]
This case at its core
is centered on Mongos’ shareholder loan account. That was the only asset relied
upon by the CRA in coming to their net worth assessment, yet they have
expressed real concern as to how the shareholder loan account was used.
Frankly, I found Mr. Lotoski’s explanation not a beacon of clarity. It struck
me as somewhat arbitrary and, indeed, an all too convenient shortcut method of
accountancy. It invites the very scrutiny that has come to pass.
[48]
I will attempt to first
describe how Mr. McLeod and Mr. Lotoski suggest the shareholder loan account
was used. I will then look at a $74,000 adjusting entry that the Appellant
argues should come off the net worth.
[49]
The real dispute here
is that the CRA believes the shareholder’s loan account was used to simply hide
revenues. The Appellant and his advisors suggest the shareholder loan account
served as a sort of clearing house, but, ultimately reflected the injection of
funds by Mr. McLeod (including the two loans).
[50]
Mr. Lotoski set up the
deposit clearing account for Mongos. All the sales and tax recorded by Mrs. McLeod
in Mongos’ books are added to this notional account. Monthly deposits are shown
in the account offsetting sales (that is, credit clearing account and debit
bank account). Similarly, any draws would be credited against the clearing
account and debited to the shareholder’s loan account. Mr. Gill, counsel
for Mongos, described the rationale is that "small businesses will often
draw funds out of their sales or cash, pay for expenses, or even pay for
personal expenses and not account for them with receipts so, at the end of the
month is that occurs there is going to be a shortfall, the deposit clearing
account will not balance and that shortfall will then go against the shareholder
loan account, will reduce the amount of the shareholder loan account. If that
taxpayer brings the accountant receipts showing what the cash is for, then that
adjustment is reversed and they get a credit to their shareholder loan account
for those receipts. Now the flip side of that is what we have seen in this
case. There was not a shortfall at the end of each month, quite often there was
an excess leftover…and the way that the accountant treats this is he gives a
credit to the shareholder loan account on the assumption that to the extent
that there is more cash around than what the sales records show, then that has
been contributed by the shareholder from his own funds."
[51]
In looking at this
notional account in Mongos’ general ledger for 2003, one can see a credit of
bank deposits in October 2002 for example, followed by a debit of cash daily
sales. At fiscal year end (September 2003), the ledger shows a balance of
$76,953, which, according to the Appellant, shows that $76,953 more has been
deposited to the bank than reflected in sales. Mr. Lotoski then zeros out the
account by adding that amount to the shareholder loan account.
[52]
In the 2004 general
ledger, Mr. Gill took me to the leasehold improvements account and shareholder
loan account which shows approximately $81,000 in leasehold improvements and an
equivalent addition to Mr. McLeod’s shareholder’s loan account, all entries
dated June 30, 2004. Mr. Gill suggests this late date being the time when Mr.
McLeod likely submitted receipts notwithstanding the work was done the previous
year. I heard no direct evidence on this point.
[53]
The final item to
address with respect to the shareholder loan account is how the catering
revenue was dealt with. Mrs. McLeod testified that while she handled the daily
bookkeeping, tallying sales from the restaurant’s servers and preparing daily
entries (though not for the period of renovations from December 2002 to August
2003) the catering revenues were not reflected in the books, but were deposited
into the bank (often by Mr. McLeod’s girlfriend). According to Mrs. McLeod,
Mr. Lotoski’s firm dealt with the catering revenue, which she believed was
allocated by him to the shareholder loan account. This resulted, according to
Mr. Lotoski, in an overstatement of the shareholder loan account, for which he
made an adjusting entry in August 2005, backing out $74,076. Mr. Lotoski
acknowledged he could not actually figure out what period the catering revenue
related to. Frankly, I was not clear from his testimony how he came to the $74,000
figure.
[54]
The Respondent’s
position in reviewing these ledgers is that because amounts that got deposited
are not round numbers, they look more like revenue than shareholder’s loan
injections. This seems more speculation than fact. I am more troubled by how
money Mr. McLeod received from Mr. Day or Ms. Crichton ultimately shows up
in the shareholder’s loan account, when Mr. McLeod left me with the impression
that he got cash from Mr. Day and paid cash out to contractors and for
supplies.
[55]
The Respondent also
questions the almost $400,000 increase in the shareholder loan account from
1999 to the end of 2004 as not credibly being funded by Mr. McLeod. Something
else is going into that shareholder loan account according to the Respondent.
The Respondent suggests that Mr. McLeod either appropriated revenues from
Mongos into the shareholder’s loan account or he had income from his other
business, Stan’s Mechanical, that he has under-reported. There is virtually no
evidence as to what Stan’s Mechanical did or did not do.
[56]
Where does this all
lead? Frankly, it leads to a messy net worth assessment based entirely on a
shareholder’s loan account, with no other assets or liabilities. The
Respondent’s position is simply that Mr. McLeod had a significant unexplained
increase in his one and only asset – his Mongos shareholder’s loan account. The
Respondent’s first position is that the shareholder loan account does not
reflect loans from Mr. McLeod to Mongos but rather an accounting appropriation
of Mongos’ revenue. In the alternative, the increased net worth is from some
other source. The Respondent need not identify the source. As indicated by
Justice Pelletier in Réjean Lacroix v Her Majesty the Queen:
18. In my view, this
jurisprudence does not establish a rule to the effect that the Minister may not
use the net worth method to add unreported income to a taxpayer’s income unless
the Minister can establish the source of the unreported income. Our tax
collection system is based on the taxpayer’s self-reporting of the income he or
she has earned during a taxation year. Should the Minister doubt, for whatever
reason, the accuracy of the taxpayer’s return, the Minister may conduct an
investigation in such manner as deemed necessary. The Minister may then make a
reassessment. If the taxpayer appeals the reassessment, the Minister does not
have to prove the facts giving rise to the reassessment. In the reply to the
notice of appeal, the Minister need only set out the presumptions of fact used
in the reassessment. The onus is on the taxpayer, who knows everything there is
to know about his or her own affairs, to “demolish” the Minister’s assumptions;
otherwise, they are presumed to be true.
Justice Pelletier went on to state:
29. This last passage
highlights the dialectic specific to certain reassessments made using the net
worth method. In the case at bar, the Minister found undeclared income and
asked the taxpayer to justify it. The taxpayer provided an explanation that
neither the Minister nor the Tax Court of Canada found to be credible.
Accordingly, there is no viable and reasonable hypothesis that could lead the
decision-maker to give the taxpayer the benefit of the doubt. The only
hypothesis offered was deemed not to be credible.
[57]
The Respondent
maintains the Appellant has not offered a credible explanation. Indeed, the
Respondent’s view is that none of Mr. McLeod’s, Mr. Lotoski’s,
Mr. Day’s and Mr. Ellis’ testimony are to be believed. That is a lot of
lying.
[58]
There is a reason net
worth assessment trials are not at the top of Tax Court judges’ list of
favourite cases. The Respondent often flies by the seat of its pants, having
received insufficient source documents and often little cooperation, and
consequently relying on guess work and gross assumptions; for example, that
Mr. McLeod has only one asset, no liabilities and the determination of
that asset is suspect. Not a well founded starting point.
[59]
The Appellant often
suffers from sloppiness or lack of attention to detail or bookkeeping that may
result in inaccurate reported income, but pleads the huge numbers suggested by
the CRA simply do not make sense: for example, a restaurant business doing
poorly, renovating for eight months and surviving for a couple of years is
unlikely to have an additional $250,000 revenue over a two year period,
especially when for eight months of those two years it was closed for
renovations. As always, reality is likely somewhere between the opposing
positions. Such cases scream out to be settled, something I suggested to the
Parties but was met with a complete absence of enthusiasm. Indeed, each side
represented they wanted to make submissions on costs depending on my Judgment.
[60]
Dealing first with the
individual Appellant, Mr. McLeod. Has he explained the approximate $240,000
increase in his net worth (being effectively the increase in his shareholder
loan account)? He has maintained he received $185,000 of loans as described
herein. As I have indicated, I believe Mr. McLeod did receive financial help.
What I am uncertain about with respect to the $155,000 Mr. Day loan is how
accurate is that $155,000 figure. With respect to the $30,000 Ms. Crichton
loan, how much of that went into Mongos and how much was used personally by Mr.
McLeod.
[61]
I find that based on
Mr. Day’s interest in helping with renovations, and the ledgers indicating an
injection of approximately $81,000 for leasehold improvements, that I accept
Mr. McLeod borrowed $81,000 from Mr. Day to go into Mongos, recorded in the
books in 2004.
[62]
On balance, I accept
Mr. Ellis’ explanation of the nature of the $30,000 loan from his aunt to Mr.
McLeod, in that it was to assist Mr. McLeod in his restaurant business, in 2003,
notwithstanding the form of the agreement. The timing accords more with Mr.
McLeod using such funds in his restaurant.
[63]
I find that $74,076 was
mistakenly included in Mr. McLeod’s shareholder loan account in 2004 as it
represented catering revenue, and accept the subsequent year’s adjusting entry
reversing that amount out of the shareholder loan account for purpose of Mr.
McLeod’s net worth assessment. The effect of these conclusions is to reduce Mr.
McLeod’s unreported income in 2003 from $83,088 to $53,088 (Crichton loan) and
to reduce his unreported income in 2004 from $164,749 to $9,673 ($81,000 loan
from Day recorded in 2004 plus $74,076 shareholder loan adjustment). Given the
significance of the unreported income in 2003 compared to income reported, I
find Mr. McLeod’s conduct was such that it amounted to gross negligence and he
is subject to section 163(2) of the Act penalties for 2003.
[64]
With respect to Mongos,
I am satisfied there was a failure to report revenues, most likely catering
revenue, though not to the extent suggested by the Respondent. In 2003, I
reduce the unreported income from $83,536 to $53,536 and in 2004, I reduce the
unreported income from $165,428 to $84,428. The adjusting entry in 2005 by
Mr. Lotoski to remove $74,076 from the shareholder loan account is, I
presume, a recognition that at least that amount was catering revenue in 2004.
I find it was significantly more than that. GST Adjustments should follow
accordingly.
[65]
With respect to
penalties, I find that Mongos is subject to the section 163(2) of the Act
penalties for 2003 and 2004 given the significance of the unreported revenue.
[66]
In the circumstances, I
make no award of costs, but should either Party wish to make costs submissions,
I ask that they do so by September 30, 2013.
Signed at Ottawa, Canada, this 28th day of August 2013.
"Campbell J. Miller"
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