Wayne Lenhardt v. Her Majesty the Queen (Informal Procedure), [1994] 1 CTC 2043

Bowman, J.T.C.C.:—These appeals are from assessments made under the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") for the appellant's 1988 and 1989 taxation years and were heard under the informal procedure. The appellant is a barrister and solicitor and a member of the Bar of Alberta. Notwithstanding section 18.15 of the Tax Court of Canada Act, the notice of appeal for 1988 consists of two sentences, as follows:

TAKE NOTICE that the appellant, WAYNE LENHARDT, does hereby appeal to the Tax Court of Canada from a notice of confirmation dated February 5, 1993, in respect to his 1988 taxation year. The appellant claims that the Minister has erred in fact and law with respect to the reassessment for the said year.

The notice of appeal for 1989 is the same except for the year. The reply to the notice of appeal was detailed and precise and it sets out fully the Minister of National Revenue's basis for assessing as he did. It is clear from the reply that three matters are in issue:

(a) The deductibility of salaries paid to the appellant's wife and to three employees (1988 and 1989);

(b) the deductibility of a portion of the rent paid on the appellant’s business premises (1988);

(c) the deductibility of the amount of debts alleged to have become bad in the year (1989).

In light of the complaints made by the appellant throughout the trial that he had not been given adequate disclosure of the Crown's position I should deal With these allegations before coming to the merits of the case. While the civil onus of proof lies upon the taxpayer to establish that the assessment is wrong (Johnston v. M.N.R., [1948] C.T.C. 195, 3 D.T.C. 1182 (T.C.C.)) or at all events that the assumptions upon which the assessment is based are wrong or that they do not justify the assessment (M.N.R. v. Pillsbury Holdings Ltd., [1964] C.T.C. 294, 64 D.T.C. 5184 (Ex. Ct.)), there is an affirmative obligation upon the Minister of National Revenue to disclose fully the legal and factual basis upon which the assessment was made (Johnston, supra). This obligation was in my view fully discharged in the reply to the notice of appeal. Moreover, the appellant had every opportunity to determine the grounds for assessing at both the assessment and the appeals levels within the departmental administrative procedures that preceded the institution of the appeal. There is no evidence that any attempt was made to do so and I have no reason to believe that any reasonable request for a detailed explanation of the adjustments made on assessing would have been denied if requested. Two letters were sent to the appellant outlining the proposed adjustments and setting out the matters in respect of which the Department required information. I do not therefore accept the contention that the appellant did not have adequate disclosure of the Crown's case.

Office rental

For 1988 the appellant claimed $19,555 as rental expense. He was allowed only $8,466.30. The amount of $11,088.70 was disallowed evidently on the basis that the appellant shared office space with a Ms. Pawluk and that he was entitled to a deduction of only a portion of the rent paid. In fact Ms. Pawluk and the appellant parted company in November 1988 after an association of about a month and thereafter the appellant was solely responsible for paying the rent. Counsel for the respondent conceded, in light of the evidence adduced by the appellant as to the payment of rent by him, that he should be entitled to a full deduction of the amount claimed, less 50 per cent of the rent of $1,454.65 paid for October 1988 when Ms. Pawluk was still sharing the office with the appellant in what appears to have been some sort of partnership arrangement. The cheque for the October 1988 rent was signed by the appellant and Ms. Pawluk on a cheque bearing the firm name Lenhardt Pawluk. There is no basis for allowing the appellant any more than the respondent has conceded. The appeal will therefore be allowed to permit a further deduction for 1988 of $10,360.67.

Salaries

This item involves the amount of salaries claimed as deductions as having been paid to three temporary workers in the amount of $4,256.44 in 1988 and $6,000 and $10,000 paid to the appellant’s spouse in 1988 and 1989, respectively.

The casual or temporary workers were a consultant, Amanda Reale, a law student, Caroleen Chisan and Sarah McCarthy, a receptionist and filing clerk. These three did not appear in the payroll records but there is no question they worked for the appellant. He put in evidence cancelled cheques totalling $5,795.34 all of which were paid in the fiscal period ending September 30, 1988 except for $432 paid to Sarah McCarthy. The difference between the amount disallowed of $4,256.44 and $5,795.34 was not explained. It is not clear from the evidence whether that difference was simply not claimed or was claimed and allowed. In the circumstances I think that the appellant is entitled to a further deduction of the amount disallowed in respect of casual labour in the amount of $4,256.44.

It was suggested by counsel for the respondent that possibly this amount had in fact been claimed and allowed and that the appellant was double counting this expense. This does not appear to have been the basis of the assessment and the evidence does not permit me to draw such an inference. The basis of assessment, as pleaded, was that the amount was either not incurred or, if incurred, was not incurred for the purpose of gaining or producing income. On the evidence I am satisfied that the wages to temporary or casual workers were paid and were laid out to earn income as part of the ongoing business of the appellant. They should therefore be deducted. Had it been clear that the entire $5,795.34 had not been allowed I would have allowed that amount but since it is not clear the additional allowance under this item is limited to $4,256.44.

The amounts paid by the appellant to his wife are somewhat more problematic. There is no doubt that a spouse is entitled to hire his or her spouse and deduct a reasonable wage or salary in computing income, provided that the terms and conditions of the employment, including remuneration, are those that would have prevailed if the parties were at arm's length (Gabco Ltd. v. M.N.R., [1968] C.T.C. 313, 68 D.T.C. 5210 (Ex. Ct.)).

Here the Minister disallowed as a deduction for 1988 and 1989 respectively $6,000 and $10,000 relating to wages paid to the appellant’s wife on the basis that they were not reasonable or were personal or living expenses.

The appellant testified that his wife worked in the office on an average of two to three days per week, and sometimes on weekends. Her work appears to have consisted of time recording and billing procedures.

The appellant adduced in evidence as Exhibit A-5 a bundle of 25 cancelled cheques signed by him and payable to his wife. Their dates run from April 15, 1988 to December 20, 1988 and they total $16,140 In cross-examination counsel for the respondent put to the appellant a letter written by him on May 29,1992 to the Department of National Revenue. This was introduced as Exhibit R-12. It enclosed copies of cancelled cheques payable to the appellant's wife, Mrs. Jane Lenhardt. This group of cheques was of quite a different composition from that submitted as Exhibit A-5. It consisted of 17 cheques dated from March 24,1988 to August 1, 1989. Of these cheques only six, totalling $5,000, were the same as those included in the 25 cheques included in Exhibit A-5. Of the remaining 11, totalling $11,000, one predated the period covered by Exhibit A-5 and ten related to the subsequent period from January to August 1989.

An examination of these cheques and of the rest of the evidence raises a number of rather perplexing questions. Among the factors that cause me concern are the following:

(a) The appellant’s wife does not appear in the payroll records nor were income tax, unemployment insurance or Canada pension plan deductions made.

(b) The timing of the payments is irregular, some coming very close together — by a day or so — others separated by a couple of weeks.

(c) The amount of the payments seems to bear no relationship to any time period of service. For example, all of the payments from December 1988 to August 1989 are in multiples of $50.

(d) The cheques after March 1989 are all signed not by the appellant but by his wife.

(e) It is admitted that one of the cheques was to pay the house mortgage. It is not clear from the evidence whether any of the other cheques were similarly for personal or living expenses.

(f) The appellant stated that at the end of the year his accountant would decide what portion of the payments to Mrs. Lenhardt should be attributed to her and what portion should, in effect, be left as taxable in Mr. Lenhardt's hands.

It is true that the onus of proof in a dvil case requires the establishment of a prima facie case, based on a balance of probabilities. It would be unreasonable for me to expect absolute mathematical precision and of course to require proof beyond a reasonable doubt would be quite wrong. In cases where a taxpayer represents himself or herself in the informal procedure I endeavour to allow to the taxpayer considerable latitude in matters of proof. Here, however, despite the fact that the appellant is a lawyer and should be able to prove his case, I am faced with evidence that is at best equivocal from which it is difficult if not impossible to determine what was paid to Mrs. Lenhardt as salary for services rendered as an employee of the appellant's business. The basis of the method employed by the accountant in attributing $6,000 or $10,000 to her was not explained. It was an arbitrary and unsatisfactory way of computing a deductible expense. Neither the accountant or Mrs. Lenhardt was called as a witness, although their evidence could have been of assistance. They should have been called and the failure to do so raises serious questions in my mind.

The result is that although I am satisfied that Mrs. Lenhardt did indeed do some work at the office and that she was paid the amounts shown in the cheques in Exhibits A-5 and R-12, I am uncertain how much was paid for her services as an employee and how much was simply a drawing for household and other personal expenses. I do not think that the threshold burden of proof has been met.

Bad debts

The same rather confused state of affairs prevails in connection with the claim to deduct bad debts of $21,605. The appellant adduced in evidence as Exhibit A-6 a schedule prepared by his wife. This document listed a number of debts that had allegedly become bad in the year.

In cross-examination Mr. Haymour, counsel for respondent, put to the appellant a letter written to the Department of National Revenue by his accountant, William Peters (Exhibit R-11). That letter, which Mr. Lenhardt stated he had never seen before, contained the following statement:

Bad Debt Write-Offs:

I enclose the accounts receivable trial balance at September 30, 1989. The items marked total $19,935.21 in doubtful accounts. The balance of the write-offs of $1,671 occurred during the year.

Attached was a computer printout of billings, organized by client and file number and opposite a number were notations made by the accountant such as"w/o" (write-off) or "write down".

The problem is that there was virtually no correlation between the amounts or indeed the clients listed on Exhibit R-11 and those listed on Exhibit A-6. Even where the clients’ names were the same the numbers were different.

In light of these serious problems in the presentation of the appellant's case I adjourned the case from October 5, 1993 to October 7, 1993 to enable the appellant to put some order in his case and to salvage what he could. When court reconvened he informed me that he could not rely on Exhibit A-6 since it was doubtful whether the amounts listed on that exhibit had been brought into income.

He therefore took me through the schedule submitted by the accountant in Exhibit R-11. It is difficult to accord much evidentiary weight to this document. It is, as previously noted, completely different from that put in evidence by the appellant as Exhibit A-6 upon which he initially based his entire case on this point.

As in the case of the amounts paid to his wife I am left in a state of uncertainty, caught somewhere between two extremes of allowin nothing and of allowing everything he has claimed. Probably some part of the payments he made to his wife were for services rendered in his practice of law. Equally it seems that some debts must have become bad in the year. This is a recurrent phenomenon in a law practice. As to the accounts written down, i.e. reduced, it is not clear whether they were in fact written down in the original determination of the aggregate revenues for the year, in which case they should not form part of the claim under paragraph 20(1)(l) or 20(1)(p) or whether they were originally included in revenue at the higher figure. It was never made clear whether the claim was for "doubtful" debts (paragraph 20(1)(l)) or“ bad debts” (paragraph 20(1)(p)).

In this somewhat unsatisfactory state of affairs I have had to consider a number of alternatives, as follows:

(a) To reject entirely the claim on those two points, the appellant's wife's salary and the bad debts. This is not a satisfactory result because he might well have been entitled to deduct some amount under these two heads. Although possibly the full amount should not have been disallowed, I can well understand, given the uninformative communications to the Department, why the departmental officials disallowed the entire claim. He has obviously given them no plausible basis upon which to allow anything.

(b) To refer the matter back to the Minister of National Revenue for reconsideration and reassessment to determine what amount should be allowed. Although the Income Tax Act confers such a power on the court it is not one that should routinely be exercised in a factual case such as this simply because a taxpayer has failed to make out his case.

(c) A third alternative would be to allow a deduction of a minimum arbitrary amount. While this might at least put an end to this rather purposeless litigation, I would not be fulfilling my obligation to decide cases upon the evidence and not on estimates of what the evidence might have established.

I cannot allow the appellant any deductions in respect of amounts paid to his wife in 1988 and 1989.

So far as the claim for bad debts is concerned, I am satisfied on the basis of the appellant's testimony that he has made out a prima facie case that the following debts, referred to in Exhibit R-11, became bad debts in the year.

Account number Amounts

*That these two figures are almost exactly the same may be attributable to coincidence or to duplication. Before the reassessment is issued the appellant should provide the departmental officials with evidence that the one figure is not a duplication of the other.

1090	$1,327.25
1083	458.06
1304	924.00
1148	154.75
1223	922.75
1044	2,683.60*
1145	155.00
1138	288.00
1189	2,683.50*
1256	105.00
Total	$9,701.91

There may well be other amounts that should be deducted but they have not been established. The amount that I am allowing to the appellant under this head falls, within a range of indeterminate magnitude, below what he might have achieved if he had proved his case fully and is certainly more than that to which he would have been entitled if I had insisted on a stricter standard of proof.

One final observation should be made. This case should never have come to court. It is the type of case, involving purely factual bookkeeping issues, that ought to have been settled at the assessment or appeals level. I think the responsibility for the present state of affairs lies with the appellant and his accountant. The letter (Exhibit R-11) sent by the accountant was uncommunicative almost to the point of disdainfulness. Had they sought to meet with the officials of the Department in a spirit of cooperation they would probably have achieved considerably more than was achieved here. Instead they chose confrontation and this approach has seriously redounded to the appellant's detriment.

The appeals are allowed and the assessments referred back to the Minister of National Revenue for reconsideration and reassessment in accordance with these reasons. This is not a case for costs.

Appeals allowed in part.