REASONS
FOR JUDGMENT
Bocock J.
I. Introduction
[1]
Both these appeals concern the Appellant’s, Mr.
Groscki’s, 2003 taxation year. However, they comprise two quite distinct
assessments within that single year.
A. Accountancy Business Assessment
[2]
The first reassessment stems from Mr. Groscki
accountancy business. Specifically, the Minister of National Revenue (the “Minister”)
reassessed Mr. Groscki, the sole proprietor of that business, under the Income
Tax Act, RSC 1985, c.1, as amended (the “Act”) on the following
basis:
a) the addition of $170,000.00 of
unreported revenue relating to certain management fees (the “management fees”);
b) the disallowance of $47,959.00 of client account receivables as a
bad debt allowance (the “bad debts”);
c) the disallowance of an insurance
expense deduction in the amount of $4,010.00 (the “insurance expense”);
B. Section 159 assessment related
to Charitable Donation Program
[3]
The second 2003 reassessment arises under
section 159 of the Act. Mr. Groscki was reassessed on June 26, 2007
(assessment number 9-070626-013963) as the legal representative in possession
and control of the property of a taxpayer having current or future tax
liability, EMI Macao Commercial Offshore Ltd. (“EMI Macao”). These bases of
assessment, after much refinement through concessions by Respondent’s counsel,
allege that Mr. Groscki, as legal representative of EMI Macao:
a)
failed to report
$538,801.00 of EMI Macao’s income (reduced from $1,295,741.00);
b)
is jointly liable
with EMI Macao for the corresponding unpaid tax liability arising during his
possession and control of EMI Macao’s property; and/or
c)
failed to obtained
a clearance certificate and, thereafter, distributed EMI Macao’s assets without
paying the corresponding tax; and/or
[4]
Although there were also distinct grounds for
reassessments relating to charitable donations, both in respect of disallowed
charitable deductions and alleged allocated capital gains in respect of gifted
property, such grounds for appeal concerning those charitable donation issues
were the subject of a consent to judgment handed up at the outset of the
hearing.
II. Accountancy
Business
[5]
The Court shall first deal with the reassessment
concerning the accountancy business.
a) Management
Fees
[6]
Mr. Groscki admitted that he did not directly
report the management fees under his statement of professional activities or for
that matter under any other source of income. The management fees were paid. There
was a cheque representing the exact sum paid to him (the “$170,000 fee”). The
amount was also reflected in the general ledger of the accountancy business as
drawings to Mr. Groscki. It did not appear plainly in the filed return or
schedules. To account for this payment, Mr. Groscki testified that he did “effectively”
report the $170,000 fee. He “pre-deducted” it against the otherwise deducted bad
debts in the same taxation year, 2003. According to Mr. Groscki, the actual bad
debt expense incurred was, in aggregate, $217,959.00, but was recorded as
$47,959.00: $217,959.00 less the $170,000 fee.
[7]
Mr. Groscki shared his logic and theory with the
Court. Since the effect upon net income was the same, Mr. Groscki offset the paid
$170,000 fee against the actually deducted bad debts, culminating in a “net”
bad debt expense of $47,959.00. This single “netted” amount was, in turn, deducted
in line 8590 (bad debts) of his statement of professional activities (T2032).
He simply skipped the step of directly reporting the revenue receipt of the $170,000
fee. He further reasoned that because the aggregate sum of $217,959.00 was
“abnormally high”, reducing it by the $170,000 fee would “normalize” the figure.
In testimony, Mr. Groscki said “I filed the bottom line number, it’s what the CRA
wants”.
[8]
Mr. Groscki cannot succeed on this ground. Professional
fees are income and bad debts are expenses. To suggest the statutory
methodology of completing each line may be ignored, provided the “effective
result” of net income or taxable income is the same, makes the reporting of
income non-compliant, misleading and absurd. In this specific case, Mr. Groscki
professional fees would have been reported as $539,217.00 rather than
$413,217.00. They were not.
[9]
The Act requires the reporting of total income
or professional fees from all sources; thereafter source income or fees may be
reduced by permitted deductions to derive net income or profit, as the case may
be. It is an elemental framework which each law, accounting and business student
learns when studying the discipline of tax from the first day. To do otherwise
ignores the wording of the Act, the intention of Parliament and the plain
truth. No reader of such a muddled return has half a chance of understanding
the statutorily mandated and logical disclosure of actual total, net and
taxable income or gross, net or taxable profit of a business or profession where
sources of income and deductions are inconsistently and capriciously
co-mingled, merged and offset in such an ad hoc fashion.
[10]
Undertaking such an activity, when it suits or
seems warranted, renders even the “net” or “effective” correctness of reported
income or fees contingent upon the accuracy of the “hidden” claimed deduction: in
this case the aggregate, but undisclosed bad debt expense of $217,959.00. With
such a method, to determine actual total income or fees, even before net income
or profit, one must evaluate deductions which clearly relate to the net or
taxable income or profit of a business or profession. Further, as described
below, the disallowance of the “hidden” offset expense ipso facto
renders all of total income or profit, the expense and net income or profit wrong.
In short, Mr. Groscki must report the $170,000 fee as professional fees or as some
other source of income in the usual method he is legally, logically and
practically required to do.
b) Bad
Debts
[11]
As noted above, Mr. Groscki really deducted
$217,959.00 of bad debts as an expense, although he reported only $47,959.00 on
his return. His testimony, documentation and logic surrounding the actual bad
debts was no more clear than that concerning the $170,000 fee. Therefore, Mr.
Groscki cannot prevail on this ground of appeal for the following reasons.
[12]
The establishment of a bad debt depends upon a timely
determination of uncollectability proximate to the year in which it becomes uncollectible:
Flexi-Coil Ltd. v. HMQ, 96 DTC 6350 (FCA) at page 6351. The only
documentary evidence of the bad debts produced by Mr. Groscki on appeal to CRA (in
March 2007) and as evidence at trial was an accounts receivable listing for the
entire business with terse, single word, hand notations regarding
uncollectibility or doubt as to collection (the “A/R list”). Aside from that, no
single, distinct client account receivable for which Mr. Groscki claimed a bad
debt expense was otherwise reflected by documentary evidence adduced before the
Court.
[13]
No actual rendered invoice, demand letter,
petition or assignment into bankruptcy of any account debtor, legal demand
letter, reminder statement, statement of claim or a finalized end of year
accounts receivable list was placed before the Court. As such, no reliable evidence
existed which established temporally proximate deliberation necessary to ascertain
that such accounts had become uncollectible and deductible as bad debts during
the 2003 taxation year or reported as an allowance for doubtful accounts in a
prior year. Further, the A/R list adduced at the hearing failed to indicate
invoice numbers, dates of rendering and/or what portion represented uncollectable
actual fees versus interest accrued, but not invoiced.
[14]
The sum total of Mr. Groscki’s discernible evidence
regarding the $217,959.00 of uncollectible accounts receivable was that the A/R
list revealed a total in excess of $560,000.00. It actually did not, it was an
adding machine tape attached to the front of the A/R list which did. Therefore,
Mr. Groscki believed that the much reduced, but hidden claimed amount of
$217,497.00 was reflective of the diminished actual bad debts incurred in 2003
for the accountancy business. Absent nominal, specific evidence regarding the
analysis and determination of one single 2003 bad debt claimed, the provisions
of the Act have not been fulfilled and no bad debt expense may be
deducted in 2003: Delle Donne v. HMQ, 2015 TCC 150 at paragraphs
81 and 82; Clackett v. HMQ, 2007 TCC 499 at paragraph 6.
[15]
The Minister’s pleaded assumptions regarding the
absence of evidence of uncollectibility and of expended efforts to collect the
debts during the 2003 taxation year remain undemolished and operative. Accordingly,
there is no “theoretical” offset against the $170,000 fee. For all these
reasons, the Minister’s reassessment stands and Mr. Groscki’s appeal in this
regard also fails.
c) Insurance Expense
[16]
The Minister disallowed claimed insurance
expenses of $4,010.00. Mr. Groscki concedes these represent the personal portion
of premiums related to his boat and the personal use portion of his residence.
It is uncontested that Mr. Groscki used his house as business and office
premises. Mr. Groscki testified that the insurance expense, which was
proportionally accurate, was already included in a $30,200.00 allocation of taxable
personal benefits to him. Accordingly, he paid income tax personally on the
benefit conveyed, but his business was denied the expense which it paid. This vague
and general ground for appeal, appeared in the notice of appeal. It was the
only denied expense item per se within the reassessment.
[17]
In contrast, Mr. Groscki was not cross-examined
on this insurance expense testimony. The CRA auditor never mentioned it when
testifying. The Minister made no assumptions regarding the issue. Notably, the
reply does not refer to the denial of the insurance expense at all. Respondent’s
counsel asserted that Mr. Groscki provided no evidence that the $4,010.00
had been included in the attribution within the T4001 allocating the $30,200.00
as personal benefits to Mr. Groscki.
[18]
Proportionally, the insurance expense issue is
small when compared to the sizeable and more complex issues before the Court in
these appeals. On objection, Mr. Groscki contested it on a consistent basis: it
was deducted, but charged back personally. In the Report on Objection, a
document before the Court, the CRA acknowledged the consistent assertion that
the personal portion of the insurance premium was added to personal income, but
nonetheless disallowed as an expense. Apart from that, the Minister has no
assumption to refute Mr. Groscki’s own evidence on the issue, albeit somewhat self-serving
and vague. Such evidence is a prima facie case, begging rebuttal. However,
it is marshalled against non-existing assumptions and need not be: Pollock v.
HMQ [1994] 1 CTC 3 at page 5. Therefore, Mr. Groscki meets and
exceeds the onus and standard of proof: Hickman Motors Ltd. v. Canada,
[1979] 2 S.C.R. 336 at paragraphs 41 to 43. Accordingly, based on the pleadings, the
assessing position taken and testimony, Mr. Groscki shall succeed in his appeal
on this ground.
III. Charitable
Donation Program and Section 159 Assessment
a) Background of the Charitable Program
[19]
The charitable donation program looms behind the
section 159 assessment. The factual background of that program, which
necessitated much of the offshore business structure at the centre of the section
159 assessment, was described at length by Mr. Groscki during his testimony. The
program is also extensively described in the case of Robert Lockie v. HMQ,
2010 TCC 142. Lockie involved the appeal of a taxpayer who participated
in the charitable donation program and had the deductibility of his charitable
donations denied. Both counsel in this appeal commended Lockie to the
Court and referenced and portrayed it in their submissions as an accurate reflection
of the charitable donation program (the “program”).
(i) the basic operational donation
program premise
[20]
In paragraph 17 of Lockie, Justice Webb,
as he then was, described the promotion materials of the program as follows:
The Respondent,
in relation to the argument that the Appellant did not have a donative intent,
relied mainly on the promotional materials distributed by Charitable
Enterprises Inc. (“CEI”). CEI was the promoter of the plan. CEI (or a related
company) had approached In Kind Canada (“IKC”), a registered charity, to
determine what products charities needed. In Kind Canada is a registered
charity that accepts donations of products and distributes these products to
other charities. CEI also had access to manufacturers in China who could
produce certain products cheaply. CEI was trying to match a need for certain
products with its source of low cost products in China. In this case, the match
was found for toothbrushes, gel pens, and school packs.
[21]
The reference to the “source of low cost
products in China” is at the heart of the section 159 assessment in this appeal.
(ii) the difference between cost
and retail price of goods
[22]
Similarly, Justice Webb accepted, as this Court
does, Mr. Groscki’s testimony regarding the EMI Group’s acquisition of
products, the price at which they were sold to donors, in turn, so they could
donate the products to charities. This is succinctly described at paragraph 40
of Lockie:
40. The statement
that the charities could not have acquired the products at the same price as
CEI is accurate but not complete. The donors (including the Appellant) did not
acquire the products at the same price as CEI. John Groscki (who appears to be
the owner of CEI and the related companies involved in the transactions)
confirmed that the company selling the products to the donors (including the
Appellant) marked these items up 3 or 4 or more times from the amount paid by
CEI (or a related company) to the manufacturers of the products.
The amount of profit generated by “CEI or a
related company” and who received it is at issue in this appeal. The Minister
alleges the related company was EMI Macao.
(iii) the twin purposes of CEI
A. The Charitable Purpose
[23]
Mr. Groscki, as he did in Lockie, also
testified extensively before the Court regarding the supply chain of the
program. From the late 90’s to 2003, Mr. Groscki laid the foundation for the
“moving parts” of the program. He identified goods in Canada which were in
demand from charities, in turn to be donated. On the charitable side, CEI would
procure the products in China and sell them at cost or somewhat above cost
(“cost”) directly to the donors. IKC, in advance, was to identify the demand
for the donations. Upon receipt of the products, they were donated to IKC. The
donor would receive a donation receipt from IKC in an amount approximately several
times greater than the cost of the goods. Essential to the proper functioning
of the program was the consistency and reliability of the quantity, quality and
delivery of the product. In this way, IKC acted as the “conduit” for the sale
by CEI to the donor on one hand, and, on the other, as the charity capable of
issuing the charitable receipt to the donor at several times the “cost” of the
product.
[24]
To conclude, as Justice Webb said in summary:
“at the end of the day… donors (were made) into wholesale … distributors of
products (indirectly or directly) to charities”: Lockie at paragraph 55.
B. The
Business Purpose
[25]
There was also a collateral secondary object.
Mr. Groscki testified that some of the product, once acquired and imported, might
be (and some apparently was) sold to merchandisers or retailers as inventory
held and marketed on a “for profit” sales basis to consumers in Canada. While
an object, it is clear this business end of the operation did not meet much success.
(iv) the demise of the charitable
program and the withering business
[26]
In December 2003, the Government of Canada announced
changes to the Act which effectively prohibited the acquisition of
products at a low wholesale cost and a subsequent charitable donation of
products in kind at an increased retail value. At this point, the companies
described in the “back office” below, which had acquired the now unsought product
(the “stranded product”) were effectively precluded from selling to individual
taxpayers at “wholesale” prices for subsequent donation at “retail” prices, the
latter being several times the former. Similarly, Mr. Groscki credibly testified
no measurable quantity of product, beyond comparatively small amounts, was sold
to retailers for sale to Canadian consumers.
b) The “back office” of the Program
[27]
A flow chart utilized by Justice Webb in Lockie
described the charitable program within the Canadian links in the chain
“after” the ordering, procurement, receipt, payment and shipping of the
products above from China. The “before” or Chinese links in that “supply chain”
are revealed in the analogous chart below (with descriptions of the primary
purpose of each entity in parentheses):
The EMI Group
Incorporated under jurisdictions in Canada Incorporated in the British
Virgin Islands
(i) Role
of the entities
[28]
EMI Corp. was the recipient importer of the
goods acquired in China, whether intended for charitable or commercial
purposes. With respect to the goods intended for commercial purposes, it
appears from testimony, it would simply directly sell to Canadian commercial
retailers or merchandizers. With respect to the charitable program, it would receive
payment at a “cost” and distribute the goods at a “fair market value” several times
in excess of the purchase price, as described extensively in Lockie by
Justice Webb. In this way, to borrow from Mr. Groscki, these donations would be
made “more efficient”.
(ii) Operational
Results
[29]
The critical period in the later months of 2003 represented
the busiest time of acquisition activities of Chinese goods undertaken by EMI
Macao and Link Zone. The books, records and financial statements detailing the
acquisitions of goods in China were not particularly helpful, but the following
chart is the approximation of the values of inventory on hand and net income
ascertained and assigned by CRA based within its alternative assessment for
each of EMI Macao and Link Zone for the period indicated.
|
Entity
|
Period Ending
|
Inventory at Recorded Cost (rounded)
|
Net Income (rounded)
|
|
EMI Macao
|
January 31, 2004
|
$490,700.00
|
$910,300.00
|
|
Link Zone
|
January 31, 2004
|
$210,300.00
|
$384,700.00
|
|
Total
|
|
$700,000.00
|
$1,295,000.00
|
[30]
The issue of the precise exactitude of these
figures, as will be seen below, may have been accurate as to quantity, but otherwise
remained critically in issue at trial. The CRA’s view is that EMI Macao and
Link Zone, as purchasers, acquired and paid for the goods in China. Link Zone and
Mr. Groscki are no longer the subject of coincident assessments for unreported
income, but such potential assessments figured prominently along with EMI Macao
in the audit, appeal and ultimate section 159 assessment levied against Mr.
Groscki.
[31]
The underlying documentation prepared by EMI
Corp’s advisors and executed by Mr. Groscki on behalf of all the concerned entities
informed the levied assessment by CRA. Two relevant agreements among the
parties were as follows:
a)
a “disbursement agent
agreement” among EMI Macao, Link Zone, EMI Corp. and CEI. Under this agreement,
CEI acted as the agent to sell such goods for EMI Macao and Link Zone. EMI
Corp. provided administration and support services to effect such sales to
donors. Although not a party to this particular agreement, Mr. Groscki was
referenced as transfer agent held all donated funds (presumably the cash donation
representing the purchase price) until title to the sold goods “is transferred”.
b)
a “sales agent agreement”
between CEI and EMI Macao. There was an identical agreement which substituted
Link Zone for EMI Macao. Under this agreement, CEI was authorized to “place
orders to sell products from EMI Macao to individuals who wished to donate the
products to registered charities”. Similarly, the escrow agent, this time not
mentioned by name, was required to hold funds in trust until “title to the
goods is transferred”. The Court is prepared to infer this was Mr. Groscki.
[32]
Reflecting EMI Macao’s ability to operate in
Macao, in October 2003, the special administrative region published a notice
stating that EMI Macao was authorized “to practise the activities offshore” in
the Special Administrative Region of Macao. Perhaps, the original text in Cantonese
and/or translation into Portuguese was clearer as to actual legal intention,
but the English must suffice. In any event, this authorization “to practice the
activities” was revoked by publication in December of 2004, effective July 21,
2004.
(iii) the stranded products’
owner(s), value, location and disposal
[33]
In December of 2003, when the legislation was
introduced to prevent “buy low, donate high” charitable donation programs, the
elaborate “donation and supply system” established by Mr. Groscki came to an
effective end. While “for profit” sales were still possible, Mr. Groscki’s credible
testimony was that EMI Macao and all others were now holding valueless, stranded
inventory. Whatever its cost (and its recorded values), the net realizable
value of the inventory from “for profit” sales was much less according to Mr.
Groscki than the realizable value previously obtained through the “efficient”
charitable donation program. Ultimately, it appears certain quantities were
imported into Canada. Similarly, there was no consistent evidence regarding the
time, duration, or actual dates for the sale or disposal of such inventory.
c) Nature of the section 159 Assessment
(i) The assessment process
[34]
The CRA audited the EMI Group, firstly in
connection with the charitable donation tax shelter and, thereafter, in
connection with the outstanding tax liability of various related companies.
(ii) The audit reports and working
papers
[35]
The CRA, whose auditor testified at trial,
concluded that an alternative assessment of EMI Macao and others was necessary.
The necessity of the alternative assessment was not challenged. It was
completed by analyzing EMI Macao and Link Zone’s inventory on hand and the
recorded sales to donors through various filings made by the tax shelter,
particularly through a review of the T5003’s: Summary of Tax Shelter
Information. The T5003’s issued to individual “donors” showed sales of
approximately $2,443,000.00. Although no clear evidence was led as to whether
these values were “cost” or “retail”, it was on that basis that the CRA
calculated EMI Macao’s tax liability and reassessed Mr. Groscki.
(iii) The remaining grounds of reassessment
[36]
The quantum of the June 26, 2007 section 159
assessment was patently erroneous on two bases. Section 159 permits the
Minister to assess a legal representative for the tax liability owed by the “legally
represented” taxpayer. Mr. Groscki, on the face of the assessment, was plainly
assessed for the amount of the alleged “unreported income” of EMI Macao, rather
than the commensurate corporate tax liability of EMI Macao. This is patently
incorrect. Under section 159, Mr. Groscki, as a legal representative, is not to
be liable as taxpayer for the unreported income of EMI Macao, but rather for
the ultimate tax liability owing of EMI Macao. At trial, the Respondent also conceded
that the amount $1,295,741.00 as income was incorrect for the purposes of the
calculating section 159 tax liability which tax liability was conceded by the
Respondent to be no more than $375,764.48.
(iv) The operative assumptions
[37]
To identify the onus of proof in this particular
appeal, the assumptions made and not made by the Minister are informative.
Relevant to the section 159 assessment against Mr. Groscki concerning the
liability of EMI Macao, the following assumptions were made (consistent
definitions have been added and underlining has been added for emphasis):
m) the appellant
is the sole shareholders of Link Zone and Export [EMI Corp in these reasons];
n) the shares of
EMI [EMI Macao in these reasons] where either held by the appellant, by Link
Zone or a combination of both;
o) the appellant
is a director of Link Zone, EMI and Export;
p) the appellant
is the sole directing mind of EMI, Link Zone and Export;
q) EMI ceased
to exist in 2004;
s) Link Zone
is the legal representative of EMI;
t) the
appellant is the legal representative of Link Zone;
w) in 2003,
the profit made from the sale of CEI tax shelter program was $1,295,741;
y) Export
failed to report to the Minister the profit made from the sale of the
CEI tax shelter program in the amount of $1,295,741;
z) in the
alternative, if the business activities were carried on by Export on behalf of
Link Zone and EMI as suggested by the appellant, Link Zone and EMI
failed to report to the Minister the profit made from the sale of the CEI tax
shelter program in the amounts of $384,774 for EMI and $910,967 for
Link Zone
[38]
It is noted, aside from the foregoing, no
assumptions in the reply were made regarding:
(i)
the value of EMI
Macao’s closing inventory as at December 31, 2003;
(ii)
the amount of
income undeclared by EMI Macao at December 31, 2004; and
(iii)
Mr. Groscki’s
capacity as a fiduciary or “legal representative” of EMI Macao or, more
appropriately for pleadings of fact, specific actions or omissions in
connection with EMI Macao which support factually such a conclusion of “legal
representative” prior to its assumed cessation of existence in June 2004.
(v) The Minister’s
relevant submissions
[39]
Apart from her assumptions, in summary, the Respondent
submits the following as reasons and justification for upholding the
assessment:
(i)
the Respondent has
established that EMI Macao had a net profit of $538,00.00 in January 2004;
(ii)
EMI Macao ceased to
exist in June 2004. Before and after that period, Mr. Groscki acted as legal
representative: the only person who could have;
(iii)
the inventory on
hand, not less than $450,000.00, was held by Mr. Groscki (in possession and control under
subsection 159(1)) and was distributed by him (distribution under subsection
159(3)) during the winding up of EMI Macao in his capacity of legal
representative; and
(iv)
factually, Mr.
Groscki’s actions fall entirely within the definition of a legal representative
in possession and control of EMI Macao’s property who, as legal representative:
(1) under subsection
159(1), is jointly liable for EMI Macao’s unpaid tax liability during the
currency he possessed and controlled the property and/or;
(2) under
subsection 159(3), failed to obtain a clearance certificate or pay the tax
liability owing prior to distributing the property under his possession and
control.
d) The necessary elements of section 159
(i) The statute
[40]
A useful excerpt of the relevant subsections of
section 159 and the relevant definition section within the Act are as
follows:
(1) Person acting
for another
159 (1) For the
purposes of this Act, where a person is a legal representative of a taxpayer at
any time,
(a)
the legal representative is … liable with the taxpayer
(i) to pay each amount payable under this Act by the taxpayer at or
before that time and that remains unpaid, to the extent that the legal
representative is at that time in possession or control, in the capacity of
legal representative, of property that belongs or belonged to, or that is or
was held for the benefit of, the taxpayer or the taxpayer’s estate, and
(ii) to perform any obligation or duty imposed under this Act on the
taxpayer at or before that time and that remains outstanding, to the extent
that the obligation or duty can reasonably be considered to relate to the
responsibilities of the legal representative acting in that capacity; and
…
(2) Every legal
representative (other than a trustee in bankruptcy) of a taxpayer shall, before
distributing to one or more persons any property in the possession or control
of the legal representative acting in that capacity, obtain a certificate from
the Minister, … , certifying that all amounts
(a)
for which the taxpayer is or can reasonably be expected to become liable under
this Act at or before the time the distribution is made, and
…
have been paid … .
Personal
liability
(3) If a legal
representative (other than a trustee in bankruptcy) of a taxpayer distributes
to one or more persons property in the possession or control of the legal
representative, acting in that capacity, without obtaining a certificate under
subsection (2) in respect of the amounts referred to in that subsection,
(a) the legal representative is personally liable for the
payment of those amounts to the extent of the value of the property
distributed; …
248 (1) In this
Act,
…
legal representative of a taxpayer means a trustee in
bankruptcy, an assignee, a liquidator, a curator, a receiver of any kind, a
trustee, an heir, an administrator, an executor, a liquidator of a succession,
a committee, or any other like person, administering, winding up, controlling
or otherwise dealing in a representative or fiduciary capacity with the
property that belongs or belonged to, or that is or was held for the benefit
of, the taxpayer or the taxpayer’s estate; (représentant légal)
(ii) The design of section 159: two distinct
vehicles
[41]
Although appearing in the same section, subsections
159(1) and the remaining 159(2) and (3) have some distinct features. As
described below, these features are not necessarily relevant in this appeal,
but they are noted. Generally, these differences may be briefly summarized.
[42]
Firstly, the potential liability under 159(1) is
joint and several whereas it becomes a “personal liability” under subsection
159(3). Recovery from the taxpayer under subsection 159(1) will diminish the
liability of the legal representative. Under subsection 159(3) the liability
becomes a singular deemed personal obligation of the legal representative.
[43]
Secondly, subsection 159(3) becomes engaged only
where a clearance certificate is not obtained. If one is obtained, the legal
representative is released to the extent of the value of that property to which
the clearance certificate relates. By contrast, this suggests that the value of
the property under subsection 159(1) is not relevant, liability accrues to the
extent of the tax debtor’s liability provided the other components are present,
implying that such possession and control could or ought to have effected
payment.
[44]
Lastly, and related to the first point, a “distribution”
by the legal representative triggers subsection 159(3), subject to the satisfaction
of the other common components. As such, reassessment under subsection 159(3),
not unlike section 160, may occur “at any time”. It is not subject to the
normal reassessment period, as is subsection 159(1). This is another contrast.
(iii) Other publications
[45]
There is little relevant case law or comparable appealed
assessments relevant to the situation where directors have been held liable
under the provisions within section 159 as a legal representative. Both counsel
alluded to this dearth of authorities in submissions. However, the Minister has
weighed in on the topic, offering up a technical interpretation bulletin 9916865
dated September 24, 1999– liability of legal representative (the “IT Bulletin”)
and Technical Notes, 159(1), October 24, 2012, TN – (the “Technical Note”).
[46]
The IT Bulletin provides as follows:
9916865
– Liability of legal representative
Reference: 159(1), 159(2), 248(1)
SUMMARY:
Liability of legal representative – ITA-159(1), 159(2), 248(1) – Extent of
liability of the legal representative of a taxpayer under subsection 159(1) of
the Income Tax Act.
Our Comments
Paragraph 159(1)(a) sets out the circumstances in which a person who is the
legal representative of a taxpayer is jointly and severally liable with the
taxpayer for unpaid amounts payable under the Act. Pursuant to paragraph
159(1)(a), the legal representative is jointly and severally liable with the
taxpayer (i) to pay each amount payable under this Act by the taxpayer at or
before that time and that remains unpaid, to the extent that the legal
representative is at that time in possession or control, in the capacity of
legal representative, of property that belongs or belonged to, or that is or
was held for the benefit of, the taxpayer or the taxpayer’s estate.
Fundamental to
section 159 is the definition of “legal representative” found in subsection
248(1) of the Act: “legal representative” of a taxpayer means a trustee in
bankruptcy, an assignee, a liquidator, a curator, a receiver of any kind, a
trustee, an heir, an administrator, an executor, a committee, or any other like
person, administrating, winding up, controlling or otherwise dealing in a
representative or fiduciary capacity with the property that belongs to or
belonged to, or that is or was held for the benefit of, the taxpayer or the
taxpayer’s estate. Whether a lawyer or a law firm that holds client funds in a
trust account for subsequent disbursement in accordance with the client’s
instructions is a trustee depends on the facts and circumstances of each case.
Thus, the final
clause of the definition is properly limited in scope to the kind of persons
that precede it, namely, a trustee in bankruptcy, an assignee, a liquidator, a
curator, a receiver of any kind, a trustee, an heir, an administrator, an
executor, or a committee. In general, the enumerated individuals stand in the
place of, and succeed to the interest in property of, another individual or
corporation. They represent the interests of, and oversee the legal affairs of,
another person. In light of the foregoing, your three questions are answered as
follows. 1. In the absence of facts and circumstances that indicate a trustee
and beneficiary relationship, it does not appear that the lawyer or law firm
acting on behalf of a client in a commercial transaction would be considered to
be a “legal representative” as defined in subsection 248(1) of the Act. …
However, under subparagraph 159(1)(a)(i), a legal representative’s liability is
limited to the property in his or her possession or control, in the capacity of
legal representative, at the time that an amount becomes payable under the Act.
[47]
In turn, the relevant excerpt from the Technical
Note provides as follows:
(say a parent
corporation that wound up its subsidiary and acquired its assets)
…
The liability of
the legal representative acting in good faith is limited to the property in the
possession and control of the legal representative when that person is called
upon to make a payment on behalf of the taxpayer, or to any proceeds of disposition
and replacement property obtained by the legal representative from that
property. … For example, a representative who has a general power of attorney
will have broader responsibilities than one whose authority is limited to certain
assets of the taxpayer.
e)
Analysis and Findings
[48]
As a third party liability and collection
mechanism, section 159 has critical components which must be present before the
provision is engaged. Simplistically these are:
i)
the third party
must be a legal representative of the taxpayer (“legal representative”);
ii)
the legal
representative must, in that capacity, be in possession and control of the
taxpayer’s property (“possession and control”);
iii)
there must be tax
liability unpaid before or during such possession and control (“accrued tax liability”);
and
iv)
further and
distinctly from subsection 159(1), before distribution occurs, a clearance
certificate must be obtained under subsection 159(2), failing which personal
liability for tax accrues to the legal representative for then owing and future
amounts of tax under subsection 159(3)(“clearance certificate”).
[49]
There is no factual dispute regarding the non-existence
of a clearance certificate or the presence of some amount of tax liability. Mr.
Groscki did not obtain a clearance certificate. The alleged tax liability remains
unpaid to the maximum of $375,764.48. Therefore, under subsection 159(1), should
the components in subparagraphs a), b) and c) above be found to exist, Mr.
Groscki would be liable for the tax liability which arose before or during his
possession and control. However, since no clearance certificate was obtained,
subsection 159(3) is also engaged. Therefore, only the components of “legal
representative”, “possession and control” in that capacity and an existing or
future tax liability must, on balance, exist. These are, within this appeal,
the common components for the engagement of subsections 159(1) and 159(3). The
severability and distinctiveness of subsections 159(1) and 159(3), otherwise
frequently relevant, are not so in this appeal. No certificate was obtained to
reduce liability under subsection 159(3), the protective assessment was levied
within the normal reassessment period and, therefore, the assessment is not specifically
related to either before or after the accrual of the liability because of the
absence of a clearance certificate in respect of property allegedly distributed.
Although deductively obvious, should the facts when applied to the law, on
balance, fail to establish any of these necessary components, the appeal shall
succeed.
(i) The meaning of “legal representative”?
[50]
The definition of “legal representative” is
fundamental to the engagement of the section. It requires action as a fiduciary
of a person legally authorized to administer, wind-up, control (as in prohibit
or permit) the distribution or dealing with the taxpayer’s property. The
representation of interests or oversight of legal affairs by the representative
must be factually present.
[51]
Counsel acknowledged that the application of
this definition in the present appeal is factual because of the lack of jurisprudence.
Prior to 1997, no stand-alone definition of “legal representative” existed in
section 248 of the Act. Instead, it was embedded within the broader
section 159 as it then existed. A re-examination of the definition and its use
in subsection 159(1) is nuanced and open to considerable interpretation,
especially to discern if an identified director, under the present
circumstances, falls within or remains without. Plainly, the title or role of director
is not expressly included in the definition, although many others are. This
allows the Appellant to plainly state the inclusion of such capacity was not legislatively
intended. Similarly, it harbours the Respondent’s contention that, in certain
factual circumstances, such as those asserted to be present in this appeal, a
director may become “a receiver of any kind”, a “liquidator” or “any like
person”. While any other named “role” within the definition is potentially
possible, these are the three highlighted.
[52]
In establishing how courts should interpret statutory
provisions, and specifically how this Court should interpret taxing
legislation, the Supreme Court of Canada in Canada Trustco Mortgage Co.,
v. R., 2005 SCR 54 at paragraph 10 directed that a textual, contextual
and purposive analysis be used. The exercise provides first stress on the text.
Then, if warranted by a hint of patent or latent ambiguity or equivocation, context
and purpose are next weighed: Canada Trustco at paragraph 47.
A.
Text
[53]
Textually, as noted, the specific term
“director” does not appear in the definition section of legal representative.
The phrases and terms, “a receiver of any kind”, “a liquidator”, and “or any
like person” and “administering, winding up, controlling or otherwise dealing
in a representative or fiduciary capacity with the property” of the taxpayer,
do appear. Ambiguity is embedded within the phrase, “or any other like person,
administering…” because of the grammatical structure. Formal or received usage
mandates a comma should not separate a phrasal clause from its predicate, but
should be used to separate a phrase or subordinate clause from the main clause
so as to avoid misunderstanding. Further, such usuage over time has changed.
Modern convention drops the separation feature of the comma in a list of items
greater than two before the conjunction “and” or “or”. Which is it? Safely, the
question of whether the phrase “or any like person administering…” is simply
part of a list or a modifier or limitation of the words preceding is not
readily apparent. The omission of the term “director” further muddies the
water. Further, in statutory interpretation, the principle of limited class
would have one limit the words “or any other like person” and “otherwise
dealing in a representative or fiduciary capacity” to the class of the previously
listed and defined terms.
[54]
The jurisprudence regarding the definition is
not specifically helpful. The closest analysis concerning a director falling
within the definition of legal representative approximates, but does not directly
answer, the question before the Court. In Parsons v. HMQ, 1983
CarswellNat 170 (FCTD) at paragraph 100, the Court found that a director was
not “any other like person” within the definition as it existed. The failure to
include the term specifically in the definition was found to be determinative.
However, Parsons concerns the declaration of dividends as the “distribution”
event. This is precisely what directors from time to time do within their
normal director powers. In the present appeal, the alleged conduct is that of
liquidation. To further dilute the authoritive impact of Parsons, it was
overturned on appeal, albeit on unrelated grounds.
B. Context
[55]
Does the context of the term “legal
representative” within the Act, as the Respondent contends in the
present case, render a director legal representative? Within the Act as
a whole, the term legal representative is used frequently and almost
exclusively in the context of executors or administrators for deceased taxpayers.
The definition itself ends with the term “or the taxpayer’s estate”. Contextually
then, this consistent use may suggest the pre-condition of death or,
presumably, some form of irrevocable dissolution in the case of a body
corporate, although, even then, the latter context is not specifically used
within the Act. This context suggest express authority conferred by
instrument or appointment specifically granting legal authority to distribute,
transfer or convey property.
C. Purpose
[56]
To identify the overall purpose, an examination
of the Interpretation Bulletin and Technical Note is permitted to gain
extrinsic insight into the policy purpose of the overall section which uses the
definition. In undertaking such an analysis, there remain some undefined definitions
in the corporate milieu. The Interpretation Bulletin concerning subsection
159(1) uses of the following words: “these amendments clarify … notwithstanding
that the taxpayer may have been “dissolved and liquidated”. Similar wording in
the Technical Note discusses a parent corporation winding up and subsuming a
subsidiary’s assets. Plainly, this relates to a body corporate. While
contextually the words seem limited to estates, guided by the Interpretation
Bulletin and Technical Note, such a broad net might catch a director acting in
such a capacity involving circumstances of dissolution and liquidation.
Justifiably, a dissolved body corporate or one that “ceases to exist” is
roughly analogous to an executor or administrator in the context of a deceased
taxpayer.
D. Conclusions
[57]
If the present context includes only examples of
deceased persons, but the extended purpose is thought to be expanded through
the Interpretation Bulletin and Technical Note, then dissolution (or cessation)
and liquidation must be considered. The question remains: how legally does a
director dissolve a corporation and liquidate the assets of a corporation as a
legal representative?
[58]
Burrowing deeper away from the present
legislation and related commentary unearths somewhat additional informative
authority: Malka et al. v. HMQ, 78 DTC 6144 (FCTD).
Helpfully, it deals with the predecessor section to section 159, section 52. In
paragraphs 16 and 17 of Malka, the Federal Court said:
16 The provisions
of subsections 52(2) and 52(3) read as follows:
52. (2) Every assignee, liquidator,
administrator, executor and other like person, other than a trustee in
bankruptcy, before distributing any property under his control, shall obtain a
certificate from the Minister certifying that taxes, interest or penalties that
have been assessed under this Act and are chargeable against or payable out of
the property have been paid or that security for the payment thereof has, in
accordance with subsection (4) of section 116, been accepted by the Minister.
(3) Distribution of property without
a certificate required by subsection (2) renders the person required to obtain
the certificate personally liable for the unpaid taxes, interest and penalties.
17 In my view, it
would not be reasonable not to consider Charles Malka as a liquidator because
he has, in fact, acted like a liquidator. To interpret subsection 52(2) in such
a formalistic way that it would not encompass a de facto liquidator
would be contrary to the provisions of subsection 52(2) even if one had no
recourse to the rule of ejusdem generis. Indeed, it would give rise to
blatant abuses as one would only have to distribute and then the Minister would
have nobody to sue for the taxes of the company. It is precisely the de facto
liquidators that are the main target of subsections 52(2) and 52(3) as they are
the ones that can be the less prone to ask for a certificate.
[59]
Factually, in Malka, the plaintiffs (two
related parties) were assessed under the then operative equivalent of section
159 for tax on the profits of Valient Shoe Import Corp. alleged to be some
$355,000.00, yielding taxes of approximately $54,000.00 in one year and
$56,000.00 in another. The basis of the relevant assessment was that the
Malka(s) had acted as “liquidators” under the then relevant section of the Act.
In the case, resolutions had been passed to wind up and/or sell assets and
shares in an attempt to acquire and use existing losses of a target company.
Ultimately, the Court found factually that the actions by the plaintiffs factually
accorded with their subsisting and unrevoked corporately authorized authority,
intention and objects to wind-up and liquidate Valient Shoe.
[60]
While not identical, the previous section 52 and
present section 159 are symmetrical enough to warrant a helpfully informative comparative
conclusion. A director, under certain circumstances, may become a legal
representative where:
(i)
additional powers
beyond directorship have been legally granted or if not, available and assumed;
(ii)
the additional
powers allowed the transformed legal representative to legally and factually
dissolve (wind-up) and liquidate the corporation; and
(iii)
the director liquidated
the assets of the body corporate by virtue of those powers.
(ii) The factual circumstances in
this appeal: is there dissolution and liquidation?
[61]
Using such a framework, Mr. Groscki could not
have been such a liquidator given the facts before the Court. The analysis and reasons
for this follow.
[62]
A “dissolution and liquidation” was not directed
by Mr. Groscki. There was scant evidence of corporate authority for Mr. Groscki
to undertake such actions qua “liquidator” “receiver of any kind” or “or
other like person”. The actions of another entity under an existing third party
ongoing agreement or document deflect rather than attract to Mr. Groscki
alleged supplemental authority as “liquidator” through his directorship.
[63]
Both logically and legally, the dissolution of a
corporation, as assumed by the Minister by virtue of the words “ceased to
exist” requires the revocation or surrender of its constating documents in the
jurisdiction of the incorporation or grant. EMI Macao was a British Virgin
Islands’ company. To that end, there was no evidence of a revocation by the
British Virgin Islands of EMI Macao’s charter or letters patent. There was no
evidence before the Court that such documents (themselves not before the Court)
were surrendered or cancelled. What occurred was a revocation, it would appear
on an unsolicited and unobserved basis, of the company’s territorial licence to
operate in Macao. The company was not legally dissolved, struck, wound up or
rendered functus by the jurisdiction which created it or by its own
director acting under resolved corporate action.
[64]
For certain, EMI Macao operated after June 2004
outside the lawful licencing requirements of Macao. It likely could not
maintain an action in that jurisdiction after that date, but there was no
evidence – as a matter of foreign law, admissible as fact - to suggest any seller
of goods in Macao or the rest of China refused to deal with the still subsisting
EMI Macao after that date. The absence of a licence to operate is not a
dissolution or cessation of existence, as assumed by the Minister, under relevant
Canadian law. To suggest that it is in Macao, while also unlikely, requires evidence
beyond that proved or assumed by the Minister. There was no evidence that EMI
Macao “ceased to exist in June 2004”.
[65]
Additionally, on balance, there was no evidence
of “liquidation”. What appears to have happened to the “property” to the extent
its alleged value is accurate, even at the hands of Mr. Groscki, was not a
conjunctive consequence of EMI Macao’s revoked status to operate compliantly in
Macao. Rather, it was the legislative change in Canada concerning donations of
the type previously undertaken by CEI that mandated the shift in the use of business
structures and entities. Link Zone and EMI Macao were no longer needed. They
were simply omitted from subsequent product acquisitions, to the extent they
were any. In effect, the existing business and inventory became stranded and
almost valueless because of hugely impactful legislative change. The evidence
supports this: EMI Corp and Mr. Groscki advanced the sums to acquire and (reluctantly
by then) import the goods directly in order to honour the commitments to suppliers
in China. This was not liquidation of EMI Macao arising from dissolution, but
merely abandonment. A review of Mr. Groscki’s testimony concerning the
acquisition, ownership, value, export and import of the assets stresses the
contemporaneous need to commercially improvise.
[66]
Further, there was no authority for Mr. Groscki
to act as liquidator. This marches along with the context and purpose of
section 159(1). Legal representatives for estates require some directive,
recognizable and informative document: a will, a trust deed, a grant of
administration or letters probate. Some instrument or action must award or
grant some authority or at least “colour of right” to “administer assets” in
the course of a dissolution, winding up and/or liquidation. The same may be
said of corporations. In the context of Parsons, the issue was the
declaration of dividends, a distribution of surplus income authorized and
witnessed by a duly passed corporate resolution. In Malka, the
authorized winding up and acquisition were present.
[67]
One might ask, what form would such documentary or
director authority take for a body corporate? For federally incorporated
business corporations, liquidation requires a special resolution of its
shareholders to appoint and authorize a liquidator: Canada Business
Corporations Act, RSC 1985 c C-44, subsection 210(3). Business corporations
incorporated in Ontario require a court order: Business Corporations Act,
RSO 1990 C.B. 16, subsections 193 and 207. In such a case, a director may be a
liquidator, but the need for a court order remains. There is no evidence such comparative
or commensurate authority or direction was conceived or intended, never mind
carried out for the British Virgin Island Company, EMI Macao. The legal
assertion that a “constructive liquidator” may be created of a director (or officer
for that matter) carrying out a triage strategy of a critically damaged
business model involving an entire group of companies stretches the text,
context and purpose of the expanded definition “legal representative” and the
section which employs it, beyond circumstances factually present in this appeal.
In short, Mr. Groscki acted within his scope of director or at least not in the
expanded capacity of liquidator.
[68]
Further, the operative business documents that
subsisted show there was no sudden departure from the business model followed by
EMI Group long before December, 2003. The disbursement agent and sales agent
agreements are just that, agreements. They do not create fiduciary relationships
beyond their terms. They do not preclude EMI Corp from dealing directly with
Chinese sellers. On close examination, the documents are intended to protect
the cash of donors by insuring that the buyer of the goods in China, EMI Macao
or Link Zone, was not paid by Mr. Groscki until the goods are imported to
Canada and title passes to the donor/distributor. As escrow or transfer agent,
Mr. Groscki bore a burden to such parties, contractually. These documents
establish such obligations of him and EMI Corp to the donors. No similar
“liquidator” or “other like person” document establishes such power, obligation
or authority on Mr. Groscki in favour of EMI Macao.
[69]
Similarly, the actions by EMI Corp or Link Zone
vis a vis EMI Macao cannot impose liability upon Mr. Groscki in the absence his
being a legal representative of EMI Macao. Facts underlying that specific
“legal representative” status were not assumed by the Minister. Further, for
the reasons stated, on balance, such facts were not proven factually for this
Court.
(iii) Was there possession and
control?
[70]
As stated, the presence of possession and
control of property of the taxpayer by a legal representative is a separate and
necessary component to establishing section 159 liability. Given the finding
that Mr. Groscki was not a legal representative, it has become moot. Someone
who is not a legal representative, but may nonetheless be in “possession and
control” of a tax debtors’ property, does not fall within section 159. However,
even if such an issue were not now moot, the following considerations would
lead the Court away from such a factual finding in the circumstances of this
appeal:
a) on balance, it is just as likely
that the entity in control and possession of EMI Macao’s property was EMI Corp
pursuant to its legal agreement to provide administrative services and import
the goods acquired by EMI Macao. The Court notes that the Minister has neither
assumed nor proven factually that EMI Corp acted in such capacity or that,
through that conduct, Mr. Groscki was a “liquidator” within the meaning of
legal representative. The fact that Mr. Groscki controlled EMI Corp as “sole
directing mind” is not relevant to his direct possession and control of the
property of EMI Macao as legal representative.
b) Mr. Groscki’s “control” was
contractually determined by and subject to the terms of the various agreements described
and the obligations contained therein. These existed well before the alleged
liquidation and dissolution comprising the critical period and existence of
“possession and control”; and
c) there were critical questions
concerning the timing and valuation of the property allegedly in Mr. Groscki’s possession
and control such that the currency of possession and control and the value of
such property at that material time were not, on balance, established.
(iv) What
was EMI Macao’s tax liability?
[71]
The tax liability of EMI Macao was ultimately
reduced by concession of the Respondent at the commencement of the appeal to a
maximum value of $375,764.48. While this underlying liability is irrelevant to
this appeal given that Mr. Groscki was not a legal representative exercising
possession and control, the following questions remain regarding the
methodological reliability of this underlying assessment:
a)
the net worth analysis
conducted did not consider the impact or input of the “for profit” side of the
business undertaken by the EMI Group;
b)
in a similar vein,
the section 159 assessment reflected a period up to December 2003 or January
2004 (it was not entirely clear from the auditor’s testimony), but even the CRA
auditor assumed EMI Macao did not cease to exist or was dissolved until June,
2004 (itself an incorrect legal conclusion). Yet, her assessment ended at the
very latest in January of 2004 which may have satisfied subsection 159(1), but
not necessarily subsection 159(3);
c)
the best and most
reliable evidence illustrates an inventory value of not greater than
$450,000.00. If this were so, as stranded inventory, it is more likely than not
that the ultimate tax liability of EMI Macao was considerably lower than the asserted
$375,764.48 since sale of that inventory would have yielded a reduced profit;
and
d)
Mr. Groscki’s
testimony regarding the value of the inventory and likely profit of EMI Macao,
while not entirely convincing, did at the very least give the Court pause
regarding the validity of the underlying assessment particularly in light of
the errors committed by the auditor both as to tax owing, unreported income and
timing when conducting the original alternative, protective assessment.
IV. Conclusion,
Summary and Costs
[72]
In conclusion and for the reasons expressed, the
appeal is granted on the basis that:
a) pursuant to a consent to judgment signed July
10, 2017 no capital gain arose from Mr. Groscki’s charitable donation made on
December 4, 2003;
b) further to the consent to judgment dated July
10, 2017, Mr. Groscki made a charitable gift on December 4, 2003 having a fair
market value of $21,335.00 and is entitled to claim a charitable donation for
such amount in taxation year 2004;
c) Mr. Groscki was not a legal representative
within the meaning of section 159 of the Act and the reassessment dated June
26, 2007 bearing number 9-070626-013963 is therefore vacated;
d) the Appellant is entitled to an additional
business expense on account of insurance premiums in the amount of $4,010.00;
e) given the result in the cause, and for clarity,
in light of the separate assessments concerning the single taxation year, all
penalties are vacated;
f) save for any subsequent order regarding costs,
if any, Mr. Groscki is entitled to no further relief; and
g) the Court shall receive written submissions on
costs within 30 days of the date of this Judgment in these appeals and asks the
parties specific address in their submissions, if any, the mixed result.
Signed at Toronto,
Ontario, this 11th day of December 2017.
“R.S. Bocock”
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