REASONS
FOR JUDGMENT
Bocock J.
I. Introduction and Preliminary Issues:
[1]
The Appellant, Mr. Liu, operates a heating and
air conditioning business, a sole proprietorship named Sun Star Enterprises
(“Sun Star”).
[2]
The Minister of National Revenue (the
“Minister”) reassessed Mr. Liu for the 2010 and 2011 taxation years. The
reassessment includes undeclared income and disallowed expenses. The quanta of
the revised reassessments are as follows:
|
Taxation Year
|
Undeclared Business Income
|
Disallowed Business Expenses
|
|
2010
|
$76,665.00
|
$17,297.00
|
|
2011
|
$43,011.00
|
$53,782.00
|
[3]
The Minister also imposed gross negligence
penalties under 163(2) of the Income Tax Act, RSC 1985, c.1, as amended
(the “ITA”) in respect to the undeclared income and disallowed expenses.
a)
Methodology of Alternative Reassessment
[4]
The Minister determined the reassessment based
upon an alternative assessment under subsections 152(7) and (8) of the Act.
The Minister argues this was necessary because Mr. Liu’s books and records were
a shambles: there were neither reliable records of revenue receipts from
customers nor disbursements on account of payments to suppliers. A bank deposit
analysis was undertaken. The methodology followed, according to the Canada
Revenue Agency (the “CRA”) witness at trial, was as follows:
|
Unexplained Deposits into Business and Personal Bank Accounts
|
Less
(-)
|
Reported Business Income
|
Less
(-)
|
Applicable GST/HST
|
Equals
(=)
|
Amount of Undeclared Income
|
[5]
Similarly, where Mr. Liu produced invoices,
receipts or vouchers for disbursements and expenses paid for business expenses,
the Minister generally revised the reassessment to decrease the unreported
income or increase expenses, as the case may be.
b)
Supplementary Documentation regarding Specific
Expenses
[6]
During the trial, Mr. Liu asserted that there
were specific additional expenses for which he could produce (but not at trial)
paid invoices to suppliers and others for business related expenses. These
related to office expenses, meals and entertainment, advertising, car and
business insurance, car repairs, fuel, parking and cellphone (the “specific
expenses”). The Minister had otherwise not deducted these amounts.
[7]
At this point in the proceedings, Mr. Liu
conceded the reassessments for unreported income were his fault. His lack of
records and consistent bookkeeping needed to be corrected. He had learned from
the reassessment and appeal process that these practices must change. However,
he was adamant that expense records for the specific expenses did exist.
Further, he indicated he appreciated presently the importance of producing them.
He said he would do so for certain specific expenses immediately following the
date set for the hearing of the appeal. While a somewhat extraordinary request,
Respondent’s counsel was not opposed. A post-hearing order was issued giving
Mr. Liu 30 days to produce invoices or receipts and brief submissions relating
to the specific expenses referenced at the hearing. He was to provide identical
copies to the Court and Respondent’s counsel.
[8]
The Respondent was given 15 days further to
reply. The Court would then render its decision. Such specific expenses related
solely to the second issue of disallowed expenses.
c)
RSP Home Buyer Plan Withdrawal
[9]
A distinct issue concerning a RSP home buyer
plan withdrawal reflected in Mr. Liu’s 2010 tax return arose before the Court.
Mr. Liu attached a T4 RSP for $8,046.17 to his 2010 tax return. The return was apparently
prepared by a tax preparer. The amount was included in line 247 of schedule 7
referencing the a home buyer’s plan withdrawal. The T4 RSP reflects such a
withdrawal for such purposes. Mr. Liu testified he purchased a house in 2010
and used the RSP withdrawal as part of a home buyer plan. The Court believes
this testimony and relies on the notation of a “HBP withdrawal” within the T4.
The exact amount of the withdrawal is further referenced by the CRA’s witness
as an unexplained deposit. The Respondent led no contrary evidence. It was also
clear at the hearing from the Respondent’s submissions and evidence of the CRA
that such withdrawal was included within the alternative assessment as
unreported income. It was not subsequently excluded in the concessions of the
Respondent culminating in the reduced reassessment before the Court. Therefore,
the Court reduces the alternatively assessed undeclared income in 2010 by the
amount of $8,046.17 which pursuant to the provisions of the Act should
not be included in income during that year where the withdrawal was otherwise
used for a home purchase.
[10]
Three remaining issues were before the Court:
the unreported income, the disallowed expenses and the gross negligence
penalties.
II. the hearing, evidence
generally and main issues:
a)
Unreported Income
[11]
During the audit, representation and hearing
stage of the reassessment, Mr. Liu had an opportunity to provide books and
records buttressing his declared and reported income. He produced no such
records.
[12]
As to the specific methodology employed by the
Minister for the alternative assessment, Mr. Liu did not present a challenge to
the calculations employed. The testimony of the CRA witness remained resolute
and unassailed on the need and method used by the Minister. Although much was
made by Mr. Liu of rental deposits relating to a property Mr. Liu owned,
the Minister gave credit for the rental income declared. Further undeclared
rent would still be undeclared income, whether income from property or income
from business. Moreover, no rental agreement, rent receipts or copies of tenant
cheques were produced as evidence by Mr. Liu of further detail to his assertion
of such deposits relating to declared income.
[13]
As to non-taxable sources of income, Mr. Liu testified
that he borrowed $22,000.00 from someone in 2011. No promissory note, cheque or
memorandum regarding the lender, term or interest rate was offered by Mr. Liu.
[14]
In Golden v HMQ, 2009 TCC 396,
Justice Boyle summarized a taxpayer’s strategy for attacking an alternative
assessment as follows:
[11] In the case of a net worth assessment,
it is open to the taxpayer to attack whether the net worth assessment is needed
or the most appropriate method of computing the taxpayer’s income from any
source. In this case the taxpayer is not doing that. If the taxpayer does
attack whether a net worth assessment is needed or the most appropriate, a
taxpayer would need to prove to the satisfaction of the Court with what
evidence there is, what records there are and other credible evidence, what the
income of the taxpayer is from the source or sources in question. The taxpayer
has not done that nor laid the groundwork in the evidence for that.
[12] The alternative is for the taxpayer to challenge specific
aspects of the net
worth assessment calculations.
[15]
In this appeal, no countervailing evidence has been
adduced by Mr. Liu to challenge the need, the methodology or non-taxable
sources of the alternatively assessed income allocated by the Minister. On balance,
the Court concludes that Mr. Liu had undeclared income in the amounts of
$65,865.63 (including the Home Buyers’ Plan Reduction) and $43,011.00 for
taxation years 2010 and 2011, respectively.
b)
Additional Specific Expenses
(i)
Post-Trial Deliveries by Mr. Liu of
Documentation re: Specific Expenses
[16]
The Court’s post-hearing order specifically
afforded Mr. Liu an opportunity to submit documentation referencing specific
expenses relating to specific categories: office, meals, entertainment,
advertising, car and business insurance, car repairs, fuel, parking and
cellular phone (the “described categories”). The records were to be in the form
of expense receipts, invoices or other documentation as described in the
testimony of Mr. Liu at trial.
[17]
Upon receipt of the documentation relating to
the specific expenses, it was clear Mr. Liu exceeded the scope of this already
exceptional opportunity to provide documentation past the hearing date. At the
hearing, the Court limited the specific expenses to the described categories.
Respondent’s counsel agreed with the process of the Court’s examination of the
documentation concerning the specific expenses within the specific categories,
but nothing beyond. Mr. Liu also confirmed his agreement with that process. On
that basis, the documentation and summaries related to credit card interest,
books and gifts have been excluded from the Court’s consideration. The parties
agreed to such and it formed the basis for the corresponding post-hearing
order. The court will deal separately such with additional internet charges.
(ii) Review of Specific Expenses
[18]
With respect to the balance of the specific
expenses relating to the specific categories, the Court conducted a review of
the supplementary documentation by specific category. In doing so, the Court
allowed expenses where the following referable documentation evidenced, more
likely than not, that an expense had been incurred to generate or earn income
for Sun Star:
(i) credit
card payments identifying a purchase from a vendor selling a specific supply,
such as a charge at a gas station for fuel;
(ii) a bank
statement identifying a payee in respect of a payment for a usual business
expense, such as business insurance;
(iii) specific
invoices from usual suppliers identifying usual business supplies such as
stationery, tools supplies and computer supplies; and,
(iv) invoices
which identified the business, Sun Star, as the purchaser of supplies or
services normally connected with a business, such as yellow pages advertising.
a.
inclusion percentage of vehicle related expenses
[19]
Mr. Liu testified at the hearing that he used
his motor vehicle 70% of the time for business. Respondent’s counsel submitted
that no more than the ratio of 70% of any such expense should be properly
deductible in respect of vehicle related expenses. Vehicle related expenses
logically include: car insurance, car repairs, parking and fuel. On that basis,
only 70% of the value of such expenses have been included in the specific
expense deduction related to motor vehicle.
b.
inclusion percentage of meals
[20]
Similarly, the Act only permits the
deduction of 50% of meals on the basis that the taxpayer must account for the
personal nature of food she or he would consume. This inclusion rate is specially
provided for subsection 67.1(1) of the Act.
c.
inclusion of internet charges
[21]
Mr. Liu did not specifically suggest internet
charges were included within the specific expenses during the trial. However,
it is also probable there was some confusion concerning the source of this
expense at trial. Mr. Liu’s internet provider and cellular phone provider were
the same entity. The invoices bear a striking similarity. Invoices for both
cellular phone and internet were submitted. Mr. Liu is the subscriber of both
sources. The Court also acknowledged that there is a personal use portion of
any internet expense for entertainment and use by other family members.
However, modern businesses do not function without internet. Based upon the
evidence submitted and that reality, it is reasonable for the Court to allow
50% of the costs incurred by Mr. Liu in respect of the internet for which he
produced invoices or other evidence of expenses.
(iii)
Calculation of Additional Specific Expenses
[22]
The following represents in table form the
Court’s allowance of additional business expenses for Mr. Liu in the 2010 and
2011 taxation years.
2010
|
Specified
Category
|
Specific
Expenses
|
Inclusion
Rate
|
Allowed
Additional Business Expenses
|
|
Fuel
|
$3,842.46
|
70%
|
$2,689.72
|
|
Car
Repair
|
$1,199.45
|
70%
|
$839.62
|
|
Car
Insurance
|
$2,265.70
|
70%
|
$1,585.99
|
|
Parking
|
$59.56
|
70%
|
$41.69
|
|
Office
Expense Supplies
|
$546.95
|
100%
|
$546.95
|
|
Business
Insurance
|
$204.27
|
100%
|
$204.27
|
|
Advertising
|
$56.60
|
100%
|
$56.60
|
|
Meals
|
$409.32
|
50%
|
$204.66
|
|
Internet
|
$1,149.84
|
50%
|
$574.92
|
|
Cell
Phone
|
$377.40
|
100%
|
$377.40
|
|
Total
|
$10,111.55
|
-
|
$7,121.82
|
2011
|
Specified
Category
|
Specific
Expenses
|
Inclusion
Rate
|
Allowed
Additional Business Expenses
|
|
Fuel
|
$7,103.88
|
70%
|
$4,972.72
|
|
Car
Repair
|
-
|
70%
|
-
|
|
Car
Insurance
|
$3,277.08
|
70%
|
$2,293.96
|
|
Parking
|
$56.85
|
70%
|
$39.80
|
|
Office
Expense Supplies
|
$21.16
|
100%
|
$21.16
|
|
Business
Insurance
|
$346.90
|
100%
|
$346.90
|
|
Advertising
|
$878.67
|
100%
|
$878.67
|
|
Meals
|
$342.01
|
50%
|
$171.01
|
|
Internet
|
$979.20
|
50%
|
$489.60
|
|
Cell
Phone
|
$411.96
|
100%
|
$411.96
|
|
Total
|
$13,417.71
|
-
|
$9,625.78
|
[23]
Therefore, Mr. Liu is entitled to deduct the
additional business expenses described above. Based upon the evidence, these
expenses were not previously allowed by CRA in the alternative assessment. The
invoices were produced by Mr. Liu. Respondent’s counsel agreed with the Court that
such invoices should be accepted where same identify what on balance are reasonable
business expenses. Therefore, Mr. Liu’s testimony and documentation in this
regard are accepted.
[24]
In aggregate, Mr. Liu is entitled to additional
business expenses of $7,121.82 in 2010 and $9,628.78 in 2011.
c)
Gross Negligence Penalties
[25]
The issue of gross negligence penalties remains.
(i) The Evidence
a. submissions and evidence
of the respondent
[26]
Counsel for the Respondent submitted that the
primary factor in determining the issue of gross negligence in the appeal is
the materiality of the undisclosed income and disallowed business expenses.
While there was a considerable concession concerning income in 2010 by the
Respondent, no such concession was made for 2011.
b. the changing magnitude
[27]
In terms of these concessions and findings of
the Court, the magnitude may be summarized as follows:
|
Year and Category
|
Original Reassessment Appealed
|
Concession by Respondent at or before Trial
|
Income Reductions or Additional Specific Expenses
|
Result After Appeal
|
|
2010 Unreported Income
|
$114,830.00
|
($40,918.00)
|
($8,046.17) Home Buyer’s Plan
|
$65,865.63
|
|
2010 Disallowed Expenses
|
$17,297.00
|
Nil
|
($7,121.82) Additional Specific Expenses
|
$10,175.18
|
|
2011 Unreported Income
|
$43,011.00
|
Nil
|
Nil
|
$43,011.00
|
|
2011 Disallowed Expenses
|
$166,685.00
|
($112,903.01)
|
($9,625.78) Additional Specific Expenses
|
$44,156.21
|
[28]
Generally, save for 2011, it is observed that in
each taxation year and category of undeclared revenue and disallowed expenses there
has been a sizeable adjustment in Mr. Liu’s favour from those amounts
alternatively assessed.
c.
no knowing omission
[29]
For the penalties to remain, the question is
whether the omission of undeclared income and unincurred expenses was a knowing
act or one arising from circumstances amounting to gross negligence. Based upon
the evidence led by the Respondent’s witness and confirmed by Mr. Liu, the issue
of his knowingly omitting income or misrepresenting expenses was not asserted. Further,
the evidence did not support a finding of knowing omission of income or
overstatement of expenses. The issue remains whether Mr. Liu’s actions or
omissions in the circumstances amount to gross negligence.
(ii) The
Law
a. the act
[30]
Section 163(2) of the Act provides as
follows:
(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…
[31]
There are two necessary elements that must be
established in order to find liability for penalties under 163(2) of the Act:
(i)
a false statement in a return; and
(ii)
… gross negligence.
[32]
There is no question of the existence a false
statement in the return. Mr. Liu admitted the errors.
b.
meaning of gross negligence
[33]
With respect to gross negligence, the test is
more nuanced. In Venne v. R., [1984] 84 DTC 6247 (FCTD) CTC 223,
“gross negligence” was defined by Justice Strayer to mean:
“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. (emphasis
added)
[34]
Any determination to apply such penalties in
each appeal is directly linked to the evidence before the Court in that case.
Such a finding is entirely based upon the circumstances, facts and issues before
the Court at the conclusion of the evidence. The onus or burden of proof to
show gross negligence remains the Minister’s to the evidentiary standard or
threshold of a balance of probabilities.
c.
gross negligence to include “wilful blindness”
[35]
It is also well settled law that gross
negligence can include “wilful blindness”. The concept of “wilful blindness”, well known
to the criminal law, was explained by Justice Cory of the Supreme Court of Canada
in the decision in Hinchey: R. v. Hinchey, [1996] 3 S.C.R. 1128 at paragraph
112. The rule is that if a party has his suspicion engaged, but then
deliberately omits to make further inquiries, seeking to remain in ignorance,
he is deemed to have knowledge. “Wilful blindness” occurs where a person who
has become aware of the need for some inquiry declines to so inquire because he
does not wish to know the truth, preferring ignorance.
[36]
The concept of “wilful blindness” is applicable to
tax cases: Villeneuve v. Her Majesty the Queen, 2004 FCA 20 at paragraph 6, and Panini v. Her Majesty the Queen,
2006 FCA 224 at paragraph 43. In Panini, Justice
Nadon made it clear that the concept of “wilful blindness” is included in
“gross negligence” as that term is used in subsection 163(2) of the Act.
He stated:
43 ... the law will impute knowledge to a
taxpayer who, in circumstances that dictate or strongly suggest that an inquiry
should be made with respect to his or her tax situation, refuses or fails to
commence such an inquiry without proper justification.
d.
legal analysis of gross negligence
[37]
It has been held that in drawing the line between
“ordinary” negligence or neglect and “gross” negligence, a number of factors
have to be considered:
(a) the magnitude of the omission in relation to the income
declared,
(b) the opportunity the taxpayer had to detect the error,
(c) the taxpayer’s education and apparent intelligence,
(d) genuine effort to comply.
[38]
No single factor supercedes. Each must be assigned
its proper weight in the context of the overall picture that emerges from the
evidence (see DeCosta v. Her Majesty the Queen, 2005 TCC 545 at paragraph 11; Bhatti v. Her
Majesty the Queen, 2013 TCC 143 at paragraph 24; and McLeod
v. Her Majesty the Queen, 2013
TCC 228 at paragraph 14).
(iii) Gross
Negligence Factors vis-a-vis the Evidence
[39]
Since no factor predominates, the Court chooses to
analyze the factors in the following sequence:
a. taxpayer’s
education and apparent intelligence
[40]
Mr. Liu was not knowledgeable or sophisticated in
matters related to tax or accountancy. He testified as such. The CRA auditor,
in the penalty report, had no knowledge of such and stated so. No evidence was
led by the Respondent at the hearing to suggest Mr. Liu had additional or even
average knowledge or skills in this regard. Mr. Liu admitted he had to learn such
and has since learned much in the area of tax compliance and maintenance of business
records. The Court believes Mr. Liu was a capable tradesman and provider of
heating and air-conditioning services and systems. It is obvious the same
cannot be said of his accounting and recording systems and for his business skills.
b.
opportunity the taxpayer had to detect the error
[41]
The errors within the tax returns and the ability
to detect same must be analyzed in the context of the factual comparisons
between the amounts originally alternatively assessed by the Minister and the
ultimate amounts of taxable income found to exist at the conclusion of the
Respondent’s concessions, removal of assessment errors and the agreed deduction
of the Specific Expenses from business income. Along with the not necessarily simplistic
nature of the tax returns which encompassed Mr. Liu employment income, business
income and expenses, rental income and spousal tax credit transfers, detection
of the error by him was not a straight forward proposition even when reviewing
the third party prepared tax return.
c.
genuine effort to comply
[42]
Mr. Liu testified that he attempted to comply with
the process to the extent he understood it. He hired an accountant. He provided
the information he gathered and retained. He filed his tax returns. He paid the
tax as indicated. However, his deficiency was manifest in the area of keeping
accurate books and records. This was the root cause of the alternative
assessment and the correlated magnitude of assessed unreported income and
disallowed expenses. It was also the reason Mr. Liu, with the indulgence of
Respondent’s counsel, was able to introduce and have deducted certain “11th
hour” Specific Expenses for the business. He had many invoices for these
expenses, they simply existed in an erzatz and unorganized fashion. Such an
effort to comply is very much after the fact once the necessity and process was
revealed, even if borne of unfamiliarity and naivety.
d.
magnitude of omission
[43]
The magnitude and materiality of the omission was
dynamic. The penalty report highlighted the magnitude of the discrepancy as
both the primary and overriding basis for the imposition of gross negligence
penalties. Respondent’s counsel in submissions stated “materiality is the only
factor” for the penalty.
[44]
The following chart traces the changing quanta of
unreported income and disallowed expenses from the time of preparation of the
penalty report until the final determination by this Court. The table includes
rounded percentages correlating to ultimate tax liability found by this Court in
relation to the Minister’s initially assessed tax liability.
|
Tax Year and Category
|
Initial Alternative Assessment from
Penalty Report
|
Amount of Reduction of Income/ increase in
Expenses
|
Ultimate Amount of Unreported Income/
Disallowed Expenses
|
Reported Business Income/ Expenses
|
Percentage of Unreported to Reported
Amount
|
Percentage Decrease in Initial Assessment
After Appeal
|
|
2010 Unreported Income
|
$114,830.00
|
($48,964.17)
|
$65,865.63
|
$47,577.19
|
138%
|
43%
|
|
2010 Disallowed Expenses
|
$17,297.00
|
($7,121.82)
|
$10,175.18
|
$18,806.55
|
54%
|
41%
|
|
2011 Unreported Income
|
$43,011.00
|
Nil
|
$43,011.00
|
$186,663.00
|
23%
|
0%
|
|
2011 Disallowed Expenses
|
$166,685.00
|
($122,528.79)
|
$44,156.21
|
$168,752.00
|
26%
|
74%
|
[45]
As always, the particular challenge for the Court
arises in cases when the consideration of penalties occurs in the absence of
knowledge or actual intent. The calculations above and the existence before the
Court reveal the vain efforts of a hardworking small entrepreneur, hopelessly
lost in the accounting and records side of a business he owned and operated
alone. At the conclusion of the evidence and findings, the omissions of income
and inclusion of undocumented expenses and costs persist. However the amounts
declared initially, conceded by the Respondent and otherwise proven by the
Appellant, cumulatively present a challenge factually to the conclusion that a
high level of recklessness and indifference exist.
(iv)
Conclusion
[46]
Altogether, the analysis of the factors above
leave the Court with a certain uneasiness in concluding that Mr. Liu was
indifferent to complying with the law or reckless to the point of reprehensible
behaviour. He was unsophisticated, admitted his failings, attempted to comply,
but through his ignorance, lack of knowledge and inexperience simply failed to
do so. This was not the case of having no records or invoices, but merely
keeping or mislaying them in an unhelpful, unorganised and unsorted manner.
This was evident, when at the end of the hearing, Mr. Liu realized such
documents existed, could be and were produced. Through the real-time
explanatory process of the hearing, Mr. Liu gained an understanding of what was
and is ultimately required. Such a revelation satisfied that Court that an abject
lack of understanding and not gross negligence was the cause of the inaccurate
returns. This lack of appreciation by Mr. Liu causes a gap in the imputation of
a high enough degree of negligence to achieve the elevated level of intentional
action or wrongful intent. As a result, the penalties are cancelled.
III. Costs:
[47]
In light of the mixed result, the general
condition and unpreparedness of Mr. Liu’s documents at the outset of the hearing
and the very helpful and useful efforts of Respondent’s counsel, the Court
shall apply its discretion and award no costs in the appeal.
Signed at Ottawa,
Canada, this 21st day of June 2017.
“R.S. Bocock”
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