Kenneth James v. Minister of National Revenue, [1993] 1 CTC 2126, 93 DTC 161

Bonner, T.C.C.J.:—The appellant appeals from assessments under the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") for the 1974, 1975, 1976 and 1977 taxation years. During those years the appellant engaged in the practice of law in the city of Toronto. On assessment the Minister of National Revenue ("respondent") added to income as reported by the appellant amounts described as "additional legal fees" and "dividends from taxable Canadian corporations" and he imposed penalties under subsection 163(2) of the Act in respect of the failures to report. It was the position of the appellant that none of the amounts so added was his income. He asserted that "the additional legal fees" were the income of Elsa Kirsten, the woman with whom he was living at the time. He asserted that the dividend should not be included in computing his income because at the time the dividend was declared he was not the beneficial owner of the share.

According to the reply to the notice of appeal the facts found or assumed by the respondent on the first issue included the following:

5 (b) at all material times, the appellant was a partner in the law firm of James & Suits;

(c) James & Suits did much of the legal work for K.C.R. investments Ltd.;

(d) the appellant also performed work outside the context of the partnership for K.C.R. Investments Ltd.;

(e) at all material times, Elsa Kirsten was living with the appellant as his commonlaw wife;

(f) during the 1974, 1975, 1976 and 1977 taxation years, K.C.R. investments Ltd. paid the following amounts to the following persons:

	1974	1975 1975	1976 1976	1977 1977
Cash to Elsa Kirsten	$6,050	$ 7,625		—
			—
Cheques to Elsa Kirsten	—	30,017.50	$30,290.63	$22,747.87
Cheque to Lydia Ribble	—	5,985	—	—
Cheque to appellant	—	6,053
				—
			—
Cheques to Pedigree Holdings	—		—	13,974.93
		—
Inc.
1976 Accounts receivable, paid			8,962
in May, 1978 to Pedigree Hold
ings Inc.
	$6,050	$49,680	$39,252.63	$36,722.80

(g) the payments referred to in subparagraph (f) above, were payments on account of legal fees owed to the appellant;

(h) each of the payees referred to in subparagraph (f) above, received those amounts as nominee of the appellant;

(i) none of the payments referred to in subparagraph (f) above, was due to or received by Urmas Suits, the appellant’s law partner in the James & Suits partnership

The appellant did not challenge the facts set out in paragraphs 5 (b), (c), (e), (f) and (i).

At the hearing of the appeals two witnesses were called, the appellant and Brian Rosenthal, an accountant whose office prepared Elsa Kirsten's 1976,1977 and 1978 income tax returns.

The appellant, in his testimony, addressed the respondent's finding that the payments to Elsa Kirsten and others were in respect of legal fees and were received by them as his nominees. He testified that during the 1974 to 1977 period K.C.R. Investments Ltd. ("K.C.R.") carried on the business of a mortgage broker. It purchased "vendor take-back” mortgages and resold them to investors such as financial institutions. The appellant's office did the legal work for the purchasers of the mortgages.

The appellant testified that Ms. Kirsten worked part-time for K.C.R. and that the payments which the respondent found to be legal fees were her compensation. He said that Ms. Kirsten's work was of a general clerical nature. She assisted K.C.R. in gathering the documentation required by the purchasers or prospective purchasers of the mortgages. She made photocopies. As well Ms. Kirsten did delivery and pick-up work. As the business of K.C.R. increased she assisted the company by providing access to sources of private funds.

The appellant specifically denied that he earned the amounts in dispute, that the payees were his nominees and that the amounts were legal fees. He asserted that the clients for whom he acted were billed by his firm for the services rendered by him and he produced copies of many accounts sent to purchasers of mortgages.

The appellant's version of events is not impossible. In its general outline it is not even improbable. Obviously the fact that a person who employs a lawyer's spouse or close friend as the client of that lawyer does not support an inference that the income earned by the spouse or friend is the income of the lawyer. However, the surrounding circumstances in this case tend to suggest that the appellant's story is at least incomplete. The appellant intervened in the compensation arrangements between Ms. Kirsten and K.C.R. to an extent which suggests that his interest in those arrangements was greater than that of a mere friend of Ms. Kirsten. It was he who kept track of amounts owed by K.C.R. to Ms. Kirsten and who arranged for payment. The amounts paid were said to have been based initially on a rate of $35 for each completed mortgage purchase transaction and subsequently on a rate of $50 for each. The rate was said to be payable by K.C.R. for each transaction completed regardless of the amount of work done by Ms. Kirsten. In other words, if for any reason whatever a transaction failed to close, no payment was made to Ms. Kirsten no matter how much work she had been required to do on it. The appellant's office staff provided the appellant with lists of completed transactions. Following verification the appellant then called upon K.C.R. for payment.

I will observe that the basis on which the appellant alleged that Ms. Kirsten was compensated is rather unusual for persons performing clerical services. The arrangement described was something more than compensation on a piece-work basis. It involved in effect a sharing by Ms. Kirsten in the chance of profit and risk of loss.

It was the appellant who for a time following the termination of the practice of paying in cash made out the cheques to Ms. Kirsten using a supply of presigned K.C.R. cheques held by him. During a subsequent period when the cheques to Ms. Kirsten were being made out by employees of K.C.R. the appellant obliterated the original entry on the reference line of two of the cheques and inserted the words "finders fees". There was no evidence that the description of the fees covered by those two cheques was at all accurate. In August, September, October and November of 1977 cheques issued by K.C.R. which were said to have been payment of Ms. Kirsten's compensation were made payable to Pedigree Holdings Inc., ("Pedigree") a company whose shares were then held by Ms. Kirsten and the appellant. Those cheques were shown on the reference line to be for a “feasibility study", a description which was clearly false. The appellant admitted to participating in the furnishing of invoices to Pedigree for feasibility studies which, if made at all, were not the consideration for which the cheques were issued. The appellant offered no explanation for his unusual interest in ensuring that the payments were described as or perhaps more accurately, misdescribed, as either finders fees or consultants fees.

The total amount paid by K.C.R. over a four-year period allegedly for the services of Elsa Kirsten was a little more than $130,000. That amount was not at all insignificant at the time. It may usefully be compared with the salary of approximately $17,000 per annum reported by Ms. Kirsten as her income in 1978 from her full-time work as a school teacher.

There was no evidence to show either the extent or the value of the clerical and delivery services which Ms. Kirsten is said to have rendered after school hours. I doubt that payments of this magnitude were made as alleged for Ms. Kirsten's services.

There was evidence from the witness Brian Rosenthal which supported to a limited extent the appellant's story that Ms. Kirsten did perform a service for K.C.R. by finding a source of funds for it. Mr. Rosenthal was a chartered accountant who prepared the income tax returns of the appellant for the years in question and of Ms. Kirsten at least for the 1976 and 1977 taxation years. He stated that Ms. Kirsten mentioned to him that K.C.R. required funds, that he had clients who had funds to invest and that Ms. Kirsten suggested that he contact the appellant. Substantial advances to K.C.R. were later made by Mr. Rosenthal on behalf of his clients. However Mr. Rosenthal stated that he was not aware of any benefit flowing to Ms. Kirsten as a consequence of the suggestion made by her. Furthermore it appears that the great bulk of the payments made to Ms. Kirsten were calculated on the per transaction completed basis and that method of calculation was said to apply to payment for clerical and delivery services and not to payment for assistance in finding financing.

I observed the appellant as he gave his evidence. I formed the impression that his answers were not entirely candid. Much of his evidence consisted of a description of an arrangement between two other persons, Ms. Kirsten and Mr. Robinson, the principal shareholder of K.C.R., and of what happened pursuant to that arrangement. According to the appellant's version of events he was in a position to observe what happened pursuant to the arrangement but was not a direct participant in it. His counsel failed to call either Ms. Kirsten or Mr. Robinson to give evidence. It was not suggested that either of them was unavailable. Counsel did point out that the relationship with Ms. Kirsten had come to an end but it does not follow from that fact that Ms. Kirsten would have been an unsatisfactory witness and, in any event, such considerations do not apply to the failure to call Mr. Robinson. The normal rule in an income tax appeal in which a taxpayer challenges the factual basis on which an assessment of tax rests is that the burden is on the taxpayer to establish on the balance of probabilities that the facts are notas found or assumed by the respondent (M.N.R. v. Pillsbury Holdings Ltd., [1965] 1 Ex. C.R. 676, [1964] C.T.C. 294, 64 D.T.C. 5184 at page 686 (C.T.C. 302, D.T.C. 5188)). The failure of the appellant to call those two persons gives rise to an inference that their evidence would not have supported the appellant's case. The respondent might have called them but on the issue of whether the payments were the income of the appellant or of Ms. Kirsten it was the appellant who ran the risk of a finding that the evidence which he did adduce was insufficient. [1] The appellant's testimony was unimpressive. I find that he has failed to discharge the onus.

In appeals where a penalty levied under section 163 of the Act is in issue the Minister of National Revenue, by virtue of subsection 163(3), bears the burden of establishing the facts justifying the assessment of the penalty. The penalties now in issue were assessed under subsection 163(2). At the relevant time subsections 163(2) and (3) read as follows:

163(2) Every person who, knowingly, or under circumstances amounting to gross negligence in the carrying out of any duty or obligation imposed by or under this Act, has made, or has participated in, assented to or acquiesced in the making of, a statement or omission in a return, certificate, statement or answer filed or made as required by or under this Act or a regulation, as a result of which the tax that would have been payable by him for a taxation year if the tax had been assessed on the basis of the information provided in the return, certificate, statement or answer is less than the tax payable by him for the year, is liable to a penalty of 25 per cent of the amount by which the tax that would so have been payable is less than the tax payable by him for the year.

(3) Where, in any appeal under this Act, any penalty assessed by the Minister under this section is in issue, the burden of establishing the facts justifying the assessment of the penalty is on the Minister.

Notwithstanding the clear language of subsection 163(3) it has been held that the burden remains on the taxpayer in respect of one element of liability for the penalty, namely, the burden of establishing that the"tax payable by him for the year" is no greater than tax assessed on the basis of the information provided by him (The Queen v. Taylor, [1984] C.T.C. 436, 84 D.T.C. 6459 (F.C.T.D.)) and I have dealt with that issue already. In considering the question whether the respondent has discharged the burden imposed on him by subsection 163(3) the failure of the respondent to call Ms. Kirsten and Mr. Robinson is again significant. Those two persons, and in particular Ms. Kirsten, were in a position to shed a great deal of light on the question whether the circumstances surrounding the appellant's failure to declare the income amounted to gross negligence. Just as it is clear that the appellant's failure to call them resulted in anincomplete view of the facts on the question whether the income was that of the appellant or of Ms. Kirsten, so also did the respondent's failure to call them leave the factual picture incomplete on the question of the circumstances in which the appellant failed to report the payments as his income. Accordingly, I have concluded that the respondent has failed to discharge the burden imposed on him by subsection 163(3).

The second branch of the appeal concerns a dividend from Pedigree which was grossed up under subsection 82(1) of the Act and included in the income of the appellant for 1976 under paragraph 12(1)(j) of the Act. In respect of that dividend the respondent pleaded that he found or assumed:

5 (k) Pedigree Holdings Inc. was a corporation of which the appellant was the sole officer and director;

(l) during the 1976 taxation year, Pedigree Holdings Inc. declared a dividend of $15,041.32 in favour of Chris Teremy;

(m) at that time Chris Teremy was 14 years of age;

(n) Chris Teremy was a cousin of Elsa Kirsten;

(o) Chris Teremy made no contribution to the capital of Pedigree Holdings Inc.;

(p) Chris Teremy did not receive the dividend for his own benefit;

to prove his own case. Therefore, until the burden of producing evidence has shifted, the opponent has no call to bring forward any evidence at all, and may go the jury trusting solely to the weakness of the first party's evidence. Hence, though he takes a risk in so doing, yet his failure to produce evidence cannot at this stage afford any inference as to his lack of it; otherwise the first party would virtually be evading his legitimate burden.

(q) the appellant received a taxable dividend of $20,055.09 in respect of the said dividend declared by Pedigree Holdings Inc . . . .

The appellant contended that at the time of the declaration of the dividend he held one of the two issued shares of the company but that he held it in trust for Christopher Teremy, son of Anna Teremy, Elsa Kirsten's sister. The appellant testified that he acquired that share in 1972 at the time of incorporation of the company and that on July 26, 1977 he transferred the share to Elsa Kirsten and bought the other issued share from the previous owner, Marie Gemmill. Although I doubt that the appellant was truthful in all respects I have no reason to disbelieve this part of his testimony.

The appellant was asked what he did with the dividend. He responded that the money remained in the company, and that when he took the company over in July of 1977 he issued a demand promissory note in the appropriate amount to Anna Teremy in trust for Christopher Teremy. This version of events was borne out by the production of the minute book of the company, copies of the share certificates and a copy of an undated declaration signed by the appellant to the effect that the share was held by him in trust for Christopher Teremy. It was borne out as well by the testimony of Brian Rosenthal, the accountant who prepared the financial statements of Pedigree both prior and subsequent to the change in ownership of the company in July of 1977. Mr. Rosenthal testified :

In the year ended October 31, 1976, there were dividends declared to shareholders of $60,833, but that dividend was reflected on the statement as a debt due to the shareholders. Subsequent to the year end, Kenneth James effectively purchased Christopher Teremy's interest in that shareholders’ loan by the deliverance of this promissory note for the amount of $30,417 which is one-half of the $60,834 owing to shareholders." [2]

I accept the evidence of Mr. Rosenthal with respect to the treatment by the company of the dividend.

The dividend cannot properly be included in the income of the appellant for the 1976 taxation year for a second reason. It was not received by the appellant or anyone else in that year. In Caldwell Trust v. M.N.R., [1990] 1 C.T.C. 2310, 90 D.T.C. 1155 (T.C.C.). I referred to the decision of the Exchequer Court in M.N.R. v. Rousseau, [1961] Ex. C.R. 45, [1960] C.T.C. 336, 60 D.T.C. 1236 and stated:

That case stands for the proposition that the entry of a credit in a taxpayer's account on the books of a corporation from which account the taxpayer was entitled to draw at his discretion does not amount to receipt by the taxpayer of the amount entered.

Subsection 82(1) of the Act authorizes the inclusion in income only of ”. . . amounts received by (a taxpayer) in the year from . . . corporations . . . as . . . dividends”. No penalty is exigible in respect to the failure to report the dividend.

In the result the appeals will be allowed and the assessments will be referred back to the respondent for reassessment on the basis that (a) the penalties in issue are to be deleted; and (b) the taxable dividend was not properly included in the appellant's 1976 income. The appellant has been substantially successful and will therefore have his costs.

Appeal allowed in part.