REASONS
FOR JUDGMENT
Hogan J.
I.
INTRODUCTION
[1]
By concurrent notices of reassessment dated
April 12, 2011, the Minister of National Revenue (the “Minister”) increased the
income tax liability of Antti J. Kotilainen (the “Appellant”) for his 2003 and
2004 taxation years. The Appellant was assessed with respect to shareholder benefits
in the amount of $96,451 for the 2003 taxation year and $70,701 for the 2004
taxation year which benefits were traceable to funds withdrawn by the Appellant
from 933093 Ontario Ltd. (the “Corporation”). The Appellant was, at all material
times, the sole shareholder of the Corporation.
[2]
The Minister also imposed gross negligence
penalties under subsection 163(2) of the Income Tax
Act (Canada) (the “Act”).
The reassessments were issued beyond the normal three-year limitation period.
[3]
The Appellant acknowledges that he received the
funds assessed to him as shareholder benefits. He also acknowledges that the
Corporation paid $50,000.00 to his former wife so that he could acquire full
title to their principal residence.
[4]
The Appellant argues that the Corporation simply
repaid part of the shareholder loans owed to him. The Appellant alleges that
the Corporation’s motel business was unprofitable throughout the period that the
Corporation carried on that business. He was required to loan funds to the
Corporation so that it could continue in business and/or revitalize the property
it owned.
[5]
I commended the Respondent’s counsel for his
assistance in ensuring that the Appellant’s documentary evidence and his case
in general were properly presented to the Court. The Appellant was under the
mistaken belief that his documentary evidence would be entered into the Court’s
record by the Respondent. The Appellant was self-represented and, as is often
the case, unfamiliar with how to present his case to the Court.
[6]
At trial, after the evidence was closed, the
Respondent’s counsel conceded that the Appellant had loaned some funds to the Corporation
in the 2002 taxation year. This concession was based on documentary evidence
submitted by the Appellant and entered into the record by the Respondent. These
documents had previously been shown to the Canada Revenue Agency (the “CRA”)
auditor during the audit of the taxpayer. The CRA auditor assigned to complete the
audit of the taxpayer did not accept the Appellant’s explanation that the
Corporation owed him the money he withdrew, because the loans were not
disclosed on the Corporation’s balance sheets. He also found unreliable the documentary
evidence presented by the Appellant to prove the amount of his shareholder loans.
[7]
The Minister now says that the Appellant
received shareholder benefits in the amounts of $50,000 (an amount paid to the
Appellant’s wife at his direction) and $44,637 for the 2003 and 2004 taxation
years respectively (collectively “the Revised Amounts”). The Respondent also
agrees that the Appellant is not liable to gross negligence penalties. The
Respondent defended the balance of the assessments.
II.
ISSUES TO BE DECIDED
[8]
The issues to be decided are:
(a) Has the Respondent discharged the onus to be met by her in order to
reassess the Appellant for the 2003 and 2004 taxation years beyond the normal reassessment
period?
(b) If yes, were the Revised Amounts properly included in the Appellant’s
income for the taxation years under appeal?
III.
BACKGROUND
[9]
The Appellant, Antti J. Kotilainen is an
architect who operates under the business name Antti Kotilainen Architect.
[10]
In the late 1980s the Appellant became a
co-investor in a 14-room motel located in Parry Sound, Ontario (the “Property”).
At that time, the motel was run-down and unprofitable. However, the Appellant
and his co-investors believed that the Property was strategically located as it
was in Parry Sound, a deep freshwater port on Georgian Bay, a popular tourist
destination forming part of Lake Huron. The co-investors planned to revitalize
the motel through capital improvements.
[11]
The initial project was unsuccessful. The
Appellant arranged to purchase the interests of his co-investors. He established
the Corporation for this purpose and became its sole shareholder. The Corporation
assumed the existing mortgage on the Property and paid nominal consideration to
the co-investors.
[12]
The evidence shows that starting around 1991 the
Appellant devoted a significant portion of his time to the redevelopment of the
Property. As a result, he let his architect’s practice wind down. Notwithstanding
the Appellant’s best efforts, the business remained unprofitable throughout the
period from 1991 to 2002. The Corporation declared tax losses amounting to
approximately $425,000 in its tax returns for that period. The Appellant claims
that he had to fund these losses to avoid foreclosure on the Property and that
he used his personal funds to do so. It appears, from the evidence that the
Corporation’s large loss carryovers weighed heavily in the Minister’s decision
not to conduct an audit of the Corporation’s activities.
[13]
The evidence shows that in 2002 the Appellant
refinanced the mortgage on his principal residence located in Toronto. The Appellant
received net loan proceeds of approximately $70,000 which were deposited in his
personal account at the Royal Bank of Canada. As alluded to above, the
Respondent’s counsel conceded that the Appellant had used more than 50% of the
loan proceeds to fund the Corporation’s operations in 2002. I observe that the
Appellant’s loan to the Corporation was not recorded as a liability on its
balance sheet for the fiscal period ending December 31, 2002.
[14]
The facts and circumstances surrounding the
audit are noteworthy. The audit began on November 20, 2008 and was terminated
on April 12, 2011 when the Minister issued the concurrent notices of
reassessment.
[15]
Initially, the audit was conducted by Rajini Masilamany.
It appears that Ms. Masilamany left government service in the spring of 2009,
prior to completing her audit. The Appellant alleges that he interacted with Ms.
Masilamany and provided her with the documents in his possession at the time. The
normal three-year limitation period expired without a waiver request by the
CRA.
[16]
The Appellant’s testimony suggests that he
believed that Ms. Masilamany was satisfied with his responses to her initial
audit inquiries. He was surprised to learn in the fall of 2010 that the audit
was still ongoing. Mr. Gajewski was assigned to complete the audit commenced by
Ms. Masilamany. It appears from the audit record that he began his audit work
on October 7, 2010. His audit notes reveal that he was being pressed to
complete the audit. He was the sole witness to appear on behalf of the
Respondent.
[17]
Mr. Gajewski met with the Appellant on November
22, 2010 to explain his audit findings. In summary, he observed that the
Corporation had remortgaged the Property on October 28, 2003. It received net
loan proceeds of approximately $235,000. Mr. Gajewski’s audit revealed that the
Appellant withdrew $96,451 in 2003 and $70,701 in 2004 out of these funds.
[18]
Mr. Gajewski told the Appellant that these
amounts would be assessed as shareholder benefits under subsection 15(1) of the
Act unless the Appellant could establish that the withdrawn amounts were not
taxable. Ultimately, he did not accept the Appellant’s explanation that the
Corporation was simply repaying loans that were owed to him.
[19]
Mr. Gajewski was very responsive to the Court’s
questions on his audit work. I asked him why he did not use the combined net
worth method to determine whether the Appellant had undeclared income under
subsection 15(1). He indicated that he was fairly confident that the
Corporation did not have undeclared income. I surmise that the Corporation’s
long history of reporting annual losses provided the CRA with the necessary
comfort in this regard.
[20]
I questioned Mr. Gajewski on why he did not
accept the Appellant’s explanation that he had loaned money to the Corporation
to fund its accumulated operating losses. There is no evidence in the record to
suggest that prior to 2003 the Corporation had access to additional third party
loans or to capital injections to fund its losses. This suggests to me that the
Appellant’s explanation is true.
[21]
I noted other deficiencies when reviewing the Corporation’s
balance sheets. Operating losses were not reflected on those balance sheets. I
surmise that the Appellant’s shareholder loans could not be properly accounted
for on the Corporation’s balance sheets without taking into account the impact
of the operating losses on the corporation’s shareholder equity account.
[22]
On this point, the Appellant explained that his
stepson prepared the Corporation’s financial statements and tax returns. The Corporation
had limited resources to pay for professionally prepared financial statements.
The Appellant’s stepson did the best he could in the circumstances. I accept
this explanation.
IV.
ANALYSIS
[23]
It is important to recall that the onus lies
with the Respondent to show that the Appellant misrepresented his income by
failing, in circumstances amounting to neglect, carelessness or wilful default,
to properly account for shareholder benefits in the Revised Amounts for each of
the 2003 and 2004 taxation years.
[24]
The fact that the Minister relied on the deposit
method to reassess the Appellant has a direct bearing on the Court’s
determination as to whether or not the Respondent has discharged her burden
under subparagraph 152(4)(a)(i) of the Act. This method was chosen over the
more accurate combined net worth method typically used by the CRA to assess
undeclared income.
[25]
The outcome of this matter may well have been
different had the combined net worth method been used to determine whether the
Appellant failed to report income in 2003 and 2004 and had the analysis covered
a period longer than just two years. That net worth method accounts for
variations in net assets that are not traceable to non-taxable sources. The
deposit method does not. Moreover, the taxpayer’s combined family income and
expenditures are accounted for under the former method and not the latter.
[26]
In the instant case, the Respondent alleged
facts that she was unable to prove. For example, in paragraph 11 of the Reply,
the Respondent alleged that the Appellant had high expenditures. No evidence
was led on this point because the deposit method does not take into account a
taxpayer’s lifestyle. The Respondent also alleged that the Appellant failed to
account for personal income other than the shareholder benefits for which he
was assessed.
No evidence was presented by the Respondent to prove this allegation.
[27]
As noted earlier, the Corporation reported
significant tax losses. From the evidence, I conclude that the Corporation’s
expenses significantly exceeded its revenue. This buttresses the Appellant’s
claim that he loaned funds to the Corporation to cover the Corporation’s cash
shortfalls and to avoid foreclosure on the Property.
[28]
I would have liked to have seen documentary
evidence that would have fully corroborated the Appellant’s testimony on this
point. However, I take comfort from the fact that the Appellant presented
documentary evidence that confirmed that he did loan funds to the Corporation
in 2002. As noted above, this loan was not recorded on the Corporation’s
balance sheets, which was consistent with the Appellant’s testimony regarding
the Corporation’s past accounting practices. The Appellant’s evidence was
nonetheless accepted as reliable by the Respondent at the termination of the
hearing. It had previously been determined to be unreliable by the auditor.
[29]
The Appellant presented an additional document
that buttresses his claim. Exhibit A-16 appears to be a copy of the
Corporation’s ledger summary showing shareholder loans for the period from 1991
to 1995. The Corporation is shown as owing its shareholder $122,000 at the end
of 1995.
[30]
The Appellant produced a second document to illustrate that the
Corporation’s operations produced negative cash flow. That document tabulates
the operating losses incurred and capital improvements made by the Corporation throughout
the relevant period. It appears to have been prepared by the Appellant’s
stepson to substantiate the Appellant’s claim that he loaned significant funds
to the Corporation. At the end of 1995, negative cash flow from operating
losses and capital improvements alone is shown to be $98,613. This is not that
far off the amount shown in the shareholder loan account ledger as the
shareholder loan amount at the end of 1995.
The Corporation’s cumulative negative cash flow, consisting solely of operating
losses and capital improvements, is shown to be at least $25,805.80 at the end
of 2002.
[31]
When a business fails or its owner faces
insolvency or bankruptcy it is not uncommon to find that bookkeeping has
suffered. In such cases, the Court can rely on testimonial evidence that it
finds credible and coherent to fill in the gaps. The events that are relevant
to the reassessments herein occurred a long time ago. I am not surprised that
the Appellant did not keep copies of his personal bank records dating back to
1991. Those years were long statute-barred.
[32]
Finally I take comfort from the fact that the
Appellant’s evidence is consistent with his subsequent actions. The Appellant
remortgaged his personal residence in 2009, using the remaining equity in that
property to fund, inter alia, the Corporation’s mortgage arrears and
back taxes.
He had little choice but to do so because he had guaranteed the Corporation’s
mortgage borrowing in 2003. Thereafter, the Corporation continued to lose
money. Unfortunately, the Appellant exhausted all of his personal wealth on the
venture and was unable to provide further assistance to the Corporation. His
home was foreclosed in 2012. He now lives temporarily in a seniors’ home. The
Corporation’s lenders also foreclosed on the Property in 2012.
[33]
The explanations offered by the Appellant
justifying tax-free withdrawals from the Corporation distinguish this case from
Lacroix, a case in which the taxpayer was found to have made a
misrepresentation of facts.
There, the Appellant was not able to provide a credible explanation for the
discrepancy that the CRA auditor found in carrying out a net worth assessment,
and so the Minister was found to have discharged the burden of proof placed
upon him by subparagraph 152(4)(a)(i) of the Act. In the case at bar, there is
a credible explanation as to why the funds withdrawn from the Corporation are
not taxable in the Appellant’s hands.
[34]
Considering all of the above, I conclude that
the Respondent failed to establish that the Appellant understated his income
for 2003 and 2004 in circumstances amounting to neglect, carelessness or wilful
default. Accordingly, the 2003 and 2004 taxation years remain statute-barred.
For these reasons, the appeals are allowed and the assessments are vacated.
[35]
While costs normally follow the cause, I find
that the Appellant greatly benefited from the assistance provided to him by the
Respondent in presenting his case. This allowed the Court to have a clearer
record on which to base its judgment. In these circumstances, it is fair that
each party bear its own costs.
Signed at Ottawa, Canada, this 17th day of January 2017.
“Robert J. Hogan”
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