Albert Cloutier v. Minister of National Revenue, [1991] 2 CTC 2469, 91 DTC 246

Tremblay, T.CJ.:—This appeal was heard on common evidence with the appeal of Mercerie Manic Inc. (86-1580(IT) in Quebec City, Quebec, on December 6, 1988. The arguments were heard on January 5 and 6, 1989, in Quebec City, and the case was taken under advisement.

1. Issue

The issue is whether the appellant, the principal shareholder in Mercerie Manic Inc, was justified in excluding from the calculation of his income for the years 1977 through 1982 the following amounts added by the Minister of National Revenue:

which total $128,506.22.

In addition, the respondent imposed penalties on the appellant pursuant to subsection 163(2) for knowingly or under circumstances amounting to gross negligence making false statements in filing a tax return.

The appellant maintains that since 1960, he had saved from his own various jobs (Hydro-Quebec, carrying passengers) and his wife's jobs (babysitting, sale of Avon products) a total of $74,500 which he kept in cash at his residence. In the years in question, he used that money to invest in his company, Mercerie Manic Inc.

According to the appellant, the respondent, in conducting his assessment, did not take his liquid amount of $74,500 into account in the original assessment.

The appellant further maintains that the reassessments for the years 1977, 1978 and 1979 were done illegally, that is, on November 15, 1984, more than four years after the date the original notices of assessment were mailed, the last of them on April 24, 1980.

2. Burden of Proof

2.1 The appellant has the burden of proving that the respondent's assessments are without basis. This burden stems from a number of court decisions, among them the judgment by the Supreme Court of Canada in Johnston v. M.N.R., [1948] S.C.R. 486; [1948] C.T.C. 195; 3 D.T.C. 1182.

The burden of proof concerning the penalties and justification for issuing a reassessment more than four years after the original notice of assessment was mailed rests with the respondent according to subsections 162(3) and 152(4) respectively.

2.2 The facts put forward by the respondent are set out in paragraph 7 of the response to the notice of appeal:

[Translation]

7. In reassessing the appellant for the taxation years 1977 through 1982, the Minister of National Revenue relied on the following facts:

a) “Mercerie Manic Inc” was duly incorporated as a company under the Statutes of Quebec on April 28, 1976;

b) the fiscal year of "Mercerie Manic Inc” ends on September 30 of each year;

c) "Mercerie Manic Inc" is engaged in the retail sale of clothing;

d) the principal shareholder and president of "Mercerie Manic Inc” is Albert Cloutier, who, in addition to his activities in the company, was employed by Hydro-Quebec in 1977 and 1978;

e) aside from the employment income from Hydro-Quebec, unemployment insurance benefits and interest income, Albert Cloutier’s source of income was "Mercerie Manic Inc”;

f) for the taxation years 1977 through 1982, the appellant reported the alleged income referred to in paragraph 2 hereof as if recited at length;

g) "Mercerie Manic Inc” had no cash register or cash register tapes prior to 1980, and sales invoices for this period have been destroyed;

h) "Mercerie Manic Inc” sales paid by credit card or cheque were not included in the income reported by "Mercerie Manic Inc”; instead the following procedure was used:

1. the appellant would ask customers who wished to pay by cheque to make the cheque out in his name;

2. similarly, sales paid by credit card would be paid direct to the appellant;

3. cheques and credit card slips would be deposited in the appellant's personal account;

4. the appellant would then withdraw the same money from his personal account and redeposit it in cash in the account of “Mercerie Manic Inc”, claiming them as advances from the director;

5. the advances from the director were additional business income not reported by "Mercerie Manic Inc” and appropriated by the appellant, and were not the appellant's personal funds;

i) between September 30, 1976, and December 31, 1982, the appellant's capital increased from $63,744.90 to $221,515.95 as indicated more clearly in a statement of assets and liabilities attached hereto as Schedule 1-1, an integral part of these presents as if recited at length;

j) in calculating his income for each of the taxation years in dispute, the appellant failed to report taxable income received during the said years by means of appropriation of business income from “Mercerie Manic Inc”, namely:

1977	$25,852.00
1978	$40,811.92
1979	$30,612.01
1980	$15,060.10
1981	$11,146.19
1982	$ 5,024.00;

k) the above-mentioned additional income, calculated using the net worth method, also includes net income from the rental of a trailer totaling $11,475.00 for the period from 1979 to 1982;

l) further, in 1982, the appellant failed to report $10,000.00 in interest received from "Mercerie Manic Inc”;

m) the appellant's personal expenses were established using a list of expenses paid in cash that he himself had drawn up on January 18, 1984, and an additional amount of $54,349.53 in expenses paid by cheque;

n) cash on hand at September 30, 1976, was less than the amount shown in Exhibit 1-1;

o) during the taxation years 1977 through 1982, the appellant misrepresented the facts through neglect, carelessness or wilful failure to report his income and tax payable by filing tax returns without reporting the full amount of his income, in particular the income appropriated from "Mercerie Manic Inc”;

p) in light of the above facts, the penalty under subsection 163(2) applies more specifically in that:

1. The additional income was considerable when compared with the income reported;

2. the additional income was not the result of technical errors, but an appropriation of funds from the company in which the appellant was the principal shareholder;

3. the appellant's investments increased faster than his reported income;

4. with respect to interest income for 1982, the appellant knew that he had received that income;

3. Facts

3.1 In his notice of appeal, the appellant made the following allegations:

1. On April 28, 1976, the appellant incorporated Mercerie Manic Inc to operate a business engaged in the retail sale of men's clothing;

2. At the time, the appellant had been employed by Hydro-Quebec (a nationalized company) since 1959;

3. During those years, the appellant had worked on the construction of various hydroelectric dams, including Carillon from 1959 to 1962 and later Manic 3 and Manic 5, and had gradually saved a fairly substantial amount of money;

4. By the time he moved to Manic 5 in the summer of 1962, the appellant had saved approximately $19,000.00;

5. By September 30, 1976, with his employment income from Hydro-Quebec, income from carrying passengers between Manic 5 and Baie Comeau, income earned by his wife babysitting and selling Avon products on the construction sites and a settlement of $19,500.00 received in 1973 as a result of an accident, the appellant had accumulated approximately $74,500 that he kept in cash at his residence;

6. Since Mercerie Manic Inc needed money for business purposes, the appellant used almost all of the $74,500 to finance the company, as well as the cheques he was still receiving from Hydro-Quebec;

3.02 As indicated in his tax returns, the appellant declared the following income for the years in question:

3.03 Following an audit, notices of reassessment were issued on November 15, 1984. The additional income totalled approximately $150,000. After a notice of objection was filed, notices of reassessment were issued on July 16, 1986, showing additional income of $128,600 and penalties as follows:

These are the notices of reassessment referred to in this appeal.

3.04 Mr. Cloutier was born in 1932. He testified that after working as a logger from 1950 to 1952, he entered the employ of Hydro-Quebec in 1953 and worked there in various capacities until 1978, including foreman in such locations as Labrieville, Manic 5 and Outarde 2, etc. In 1978, he entered the employ of Mercerie Manic Inc., which he had incorporated in 1976.

3.05 To finance the business, he gave the Canadian Imperial Bank of Commerce $35,000 in collateral against a line of credit of between $45,000 and $48,000. The place of business was the Galerie de Baie Comeau shopping centre.

3.06.1 The appellant maintains that at the time he had $74,500 in cash as alleged in paragraph 5 of the aforementioned notice of appeal (para 3.01). He claims to have used this money for car repairs, repairs to the store, to purchase Mastercharge credit card slips and for post-dated cheques.

3.06.2 The evidence shows that the appellant and Mercerie Manic Inc used several banks:

1. the Royal Bank of Canada, Place Ville-Marie, Montreal, where the appellant's paycheques from Hydro-Quebec were deposited;

2. the Royal Bank of Canada in Hauterive;

3. the National Bank of Canada (NBC) in Hauterive, where the appellant had his personal account, the account in which he deposited post-dated cheques and questionable cheques from customers;

4. the Bank of Montreal, where the Mastercharge credit card slips were deposited; this was a joint account in the names of Mr. Cloutier and Mercerie Manic Inc;

5. the Canadian Imperial Bank of Canada branch in the Galerie de Baie Comeau shopping centre, where Mercerie Manic Inc. conducted its business; the account at this bank was a joint account in the names of Mercerie Manic Inc. and Albert Cloutier.

3.07 The evidence is substantial concerning the financing of Mastercharge credit card slips and a number of cheques.

3.07.1 The financing of Mastercharge credit card slips was explained as follows:

3.07.1(a) Since he claims he was able to deposit them only in the Bank of Montreal in Baie Comeau approximately eight or nine miles from his residence, he would only go to make a deposit once a week. Thus, when a customer paid for a purchase with a credit card, he would use his own money (taken from his $74,500 reserve or elsewhere) to “buy” the slip for the amount shown. This amount would be deposited with the daily deposit in the Canadian Imperial Bank of Commerce located not far from the store. He did not have to use the same method for Visa and Chargex cards because he deposited them at the nearby Canadian Imperial Bank of Commerce.

3.07.1(b) To confirm these statements, the appellant produced as Exhibit A-1, which contains nine pages of various photocopies, a deposit made on June 14, 1982, in the Baie Comeau Bank of Montreal in the names of Mercerie Manic Inc. and Albert Cloutier totaling $273.98, broken down in the following amounts: $71.00, $29.98, $165 and $8. The bank statement dated June 30, 1982 (Exhibit A-1(4), also shows that on June 14, there was a deposit of $273.98. Photocopies of two payments made by Mastercharge on June 5, 1982, one in the name of Gislaine Dupuis for $165.00 (Exhibit A-1 (1)) and one in the name of Gaétan Dupuis for $8.00 (Exhibit A-1 (3)). These two amounts also appear on the list of sales (cash register tape) for June 5, 1982, which sales totalled $550.62 (exhibits A-1(1) and A-1(3)). It also appears that on June 7, 1982, the appellant deposited $1,340.25, the total of the sales for June 4 ($789.69) and June 5 ($550.56), in the Canadian Imperial Bank of Commerce in the names of Mercerie Manic Inc. and Albert Cloutier. According to the daily balance sheet (Exhibit A-1(2)), this deposit included $990.46 in cheques, one Chargex slip for $295 and $54.79 in cash. If, as Mr. Cloutier claims, he bought two slips totalling $173 ($165 and $8) from June 5 and thus paid for these in cash, why does the deposit for June 7 show only $54.79 in cash and not at least $173? Did he perhaps write a cheque on another bank account? No, because the biggest cheque was for $150.00. Perhaps only part? It is rather strange that all the customers would have paid for their purchases by cheque or credit card and that none or so few would have paid by cash.

3.07.1(c) According to Exhibit A-1(8), $260 was deposited in the Bank of Montreal in Baie Comeau on June 15, 1982. The photocopy of the Mastercharge payment in the amount of $260.00 bears the signature of Gislain Lepage and is dated June 14, 1982 (Exhibit A-1(6)). The merchant's deposit slip dated June 15 and signed by Albert Cloutier is also in the amount of $260. The list of sales (cash register tape) for June 14, 1982, totalling $618.20 shows an amount of $260, as does the daily balance sheet (Exhibit A-1(7)). On June 15, 1982, a deposit of $618.20 was also made in the Canadian Imperial Bank of Commerce. This deposit included cheques totalling $215.50 and cash totaling $402.70 (Exhibit A-1(8)).

Finally, Exhibit A-1(9) is a photocopy of the receipt book for June 1982 which shows sales for June 4 and June 5 of $789.69 and 550.56 respectively and the deposit of $1.340.25. The same document also shows sales for June 14 of $618.20 and the corresponding deposit of $618.20.

3.07.1(d) Similarly, Exhibit A-2, which comprises six pages, shows purchases paid for by Mastercharge in the amounts of $71 (May 29, 1982, signed by Christian Bergeron) and $29.98 (May 27, 1982 signed by Ms. D. Smith), while the bank deposits and cash register tapes indicate sales including $71.00, and $29.98. The daily balance sheet similarly confirms the mechanism explained by the appellant.

Thus for four amounts of $71.00, $29.98, $165 and $8 shown on the June 14 deposit in the Bank of Montreal are explained subject to one question (paragraph 3.07.1(b) in fine).

3.07.1(e) Similarly, Exhibit A-3, which comprises four pages of photocopies, includes the deposit on June 23, 1982, in the Bank of Montreal in Baie Comeau confirming Mastercharge payments of $65.69, $20 and $28. The cash register tape, the daily balance sheet and the deposit in the Bank of Commerce also confirm the total deposit of sales each day in the Canadian Imperial Bank of Commerce and another deposit in the Bank of Montreal of Mastercharge payments.

3.07.1(f) Exhibit A-4 was the Bank of Montreal deposit book for the period from December 23, 1981, to December 9, 1983. There were 46 deposits, all of them related to payments made by Mastercharge. Shown are deposits in the amounts of $71, $29.98, $165, $8, $260, $65.69, $20 and $28 referred to above, the receipt book for the period from August 1980 to July 1983 and the original cash register tapes of which photocopies were included in Exhibits A-1, A-2 and A-3.

3.07.1(g) Exhibit A-5 was the Bank of Montreal deposit book for the period from May 25, 1979, to December 14, 1981. There were 49 deposits, all of them related to payments made by Mastercharge. A number of mastercharge payments that could be traced in a cash register tape included in Exhibit A-5 were underlined.

Finally, Exhibit A-5 also included a book of Canadian Imperial Bank of Commerce deposit slips for the period from March 3, 1981, to May 7, 1981, showing 48 deposits. This is the account into which regular deposits were made.

3.07.1(h) According to Exhibit 1-10, prepared by Mr. Bouchard, the respondent's investigator, using Bank of Montreal deposits (Exhibit A-5), purchases made by Mastercharge for Mercerie Manic Inc's fiscal year 1977 through 1981 (that is, from October 1 of one year to September 30 of the next) were as follows:

The total for 1982 (October 1, 1981, to September 30, 1982), which was not shown in Exhibit I-10, was compiled from the same source (Exhibit A-5).

3.07.1(i) Also according to Exhibit 1-10, the appellant invested $4,000 in Mercerie Manic Inc, in the 1978 fiscal year. According to the Bank of Montreal account, he apparently also made deposits to a personal bank account of $2,000 in 1979, $5,000 in 1980 and $2,000 in 1981.

3.07.2 With respect to post-dated cheques and questionable cheques, he used a scheme similar to the one explained above for Mastercharge slips. He asked his customers to make cheques out in his name and not in the name of Mercerie Manic Inc. He claimed he used this scheme in anticipation of legal action against the people who signed the cheques: legal action is easy for him in small claims court, whereas a company cannot take action in small claims court, where cases are dispensed with quickly. Seven or eight times a year, the appellant took people to small claims court to collect on cheques. No evidence was adduced concerning the amount of money used for the purpose of collecting on cheques.

3.08 The appellant maintains that he never kept sales invoices. He did not believe that he had to keep invoices. He did, however, keep a cash/receipts book, a book of expenses and deposit books for the Bank of Montreal and the Canadian Imperial Bank of Commerce. He also kept a general ledger. He started keeping cash register tapes in 1980.

3.09 The respondent's auditors found that between July 3, 1982, and September 30, 1982, the cash register was used 80 times without a sale being recorded (Exhibit A-5). Mr. Cloutier responded that this was because a telephone booth and kiddy rides that operated on 25 cent coins were located near his store. Two other stores near him would not make change, but he and his wife would to accommodate people.

3.10 Mr. Cloutier explained that for the 1978 fiscal year, Mercerie Manic Inc. made only a five per cent gross profit as shown in the financial statements. The reason is that too much stock was purchased in the fall of 1977. He had little experience and had listened too closely to the advice of another person. Acting on the advice of a salesman, he sold what he could sell at a loss and donated what he could not sell to "Le Vestiaire", a charitable organization located in the basement of the church.

3.11 Regarding the $74,500 in cash he said he had in 1976, he gave the following explanation, beginning in 1959, using Exhibit A-6, a reconciliation of income and expenses from 1962 to 1982.

3.11.1 At the time of his marriage in 1959, he claims he had $10,000. He then bought a car for $3,000, leaving a balance of $7,000. Between 1959 and 1962, he saved $12,000 from his job and his wife's work as a babysitter; she also sold clothing in the village. Later, she took over the post office in Amicoua at Manic 3, located 135 miles from Baie Comeau. The appellant, when he went to Baie Comeau on the weekends, would take five passengers at $10 a person. In 1964, he also sold for $7,000 a house that he had built in Gaspe in 1952. In addition, between 1962 and 1967, he made loans to his brother, Laurent, totaling $6,250. Further, between 1976 and 1982, his brother paid back $8,000, which is acknowledged by the respondent.

3.11.2 The respondent also acknowledges all the employment income from 1962 to 1976 as shown in Exhibits A-6 and A-7 (letter from Hydro-Quebec) plus $19,300 in 1977 and $13,675 in 1978.

3.11.3 The only salary Mr Cloutier received from Mercerie Manic Inc. was $10,296.00 in 1981. The respondent filed as Exhibit 1-3 a statement of Mr. Cloutier's income from 1975 to 1982, which shows the following:

3.11.4 The results of the reconciliation of income and expenses at the end of each year from 1962 to 1982 is also shown cumulatively in Exhibit A-6. These are:

3.11.5 In 1976, the appellant says he had $35,000 in the Caisse d'entraide economique. This amount was used as collateral for a line of credit from the Canadian Imperial Bank of Commerce. The appellant also says he had $74,500 in cash in the refrigerator at the beginning of 1976. This amount comprised $55,000 that he withdrew from the National Bank of Canada at Manic 3 in 1971 and 1972, plus $19,500 he received from an insurance company in 1973 following an accident in 1971. Exhibit A-6 shows an amount of $19,599,26 as income from accident insurance.

It was impossible, following the notices of reassessment issued by the respondent, to obtain from the National Bank of Canada at Manic 3 statements for deposits between 1960 and 1970.

3.11.6 In September 1976, according to Exhibit 1-11 (schedule III) prepared by Mr. Simard, witness for the respondent, the appellant's assets were as follows:

Since he had no debts, his net worth was $77,8744.90 according to Mr. Simard, who prepared the document. Of course, the document does not take into account the $74,500 the appellant claims he had in the refrigerator.

At September 3 of the years 1977 through 1982, the liquid assets and net worth were as follows, also shown in Exhibit 1-11 (schedule III):

It should be noted that in Exhibit I-ll (Schedule III), the calculation of net worth for each of the years 1979 through 1982 shows assets of $56,048.83 (land and house: $39,000; trailer: $6,000: snowmobile: $1,200; trailer and house furniture: $9,848.83). These assets do not appear in the appellant's analysis of the cash reconciliation (Exhibit A-6).

3.12 The appellant first had the idea to go into business for himself in 1971. That is why he decided to start saving cash. As he openly admitted, if his business ever went bankrupt, he did not want to lose everything.

He told no one other than his wife about the cash, not his bank manager, not his accountant, not even the income investigators.

While Mr. Cloutier had $74,500 in cash on hand that was not earning interest, he had a $35,000 certificate with the Canadian Imperial Bank of Commerce that was earning interest (Exhibit I-11, Schedule VI).

3.13 Mr. Simard determined Mr. Cloutier's additional income according to the calculations in Exhibit 1-11, Schedule IV. This document was changed, however, by Exhibit 1-12, as the respondent took into account the additional capital cost allowance.

3.14 According to Exhibit A-6 at page 4, the appellant claimed $325 as an expense for moving his trailer from Amicoua to Hauterive. In his 1976 tax return, he apparently claimed an expense of $2,823.65 according to form T1-M (Exhibit 1-13) entitled "Request for Deduction of Moving Expenses", which applies to individuals whochange their place of work in Canada and have to move at least 25 miles from their previous residence (section 62 ITA).

The expenses were broken down as follows:

This figure would likely affect the total for 1976 as calculated by Mr. Cloutier (Exhibit A-6). Because of this error and the failure to include in 1982 the $10,000 in interest (Exhibit 1-3, op cit, para 3.12), Mr. Simard had serious doubts about the credibility of Exhibit A-6.

3.15 With respect to the appellant's living expenses in the years 1977 through 1982, Exhibit A-6, page 4, shows the following totals:

(Exhibit 1-13) entitled "Request for Deduction of Moving Expenses", which applies to individuals who change their place of work in Canada and have to move at least 25 miles from their previous residence (section 62 ITA).

The expenses were broken down as follows:

This figure would likely affect the total for 1976 as calculated by Mr. Cloutier (Exhibit A-6X Because of this error and the failure to include in 1982 the $10,000 in interest (Exhibit 1-3, op cit, para 3.12), Mr. Simard had serious doubts about the credibility of Exhibit A-6.

3.15 With respect to the appellant's living expenses in the years 1977 through 1982, Exhibit A-6, page 4, shows the following totals:

Another document dated January 18, 1984, and signed by the appellant and his wife was filed by the respondent as Exhibit 1-14. This document shows the following totals:

The respondent initially calculated the following figures based on his investigation:

The respondent subsequently prepared a new document (Exhibit 1-16) that reduced the totals, considering expenses paid by cheque and taxes paid to arrive at the following new totals for living expenses:

Comparing these last figures with those of the appellant, the figures for 1977 and 1978 are acknowledged by the appellant. The following differences remain:

The appellant maintains, however, that his actual living expenses are those indicated in Exhibit A-6 at page 4, namely:

3.16 The appellant maintains that during the years 1976 through 1982, he did not earn as much money from Mercerie Manic Inc. as the department suggests. In 1978 and 1979, two clothing stores in the same shopping centre as Mercerie Manic Inc. went bankrupt. It was hard, and those who survived did not necessarily make huge profits. The only logical explanation according to the appellant is that the $74,500 he had in 1976 is included in the $113,510.58 he personally invested in the company between 1977 and 1982.

According to the notices of reassessment for the years in question. Mr Cloutier's additional income was $128,506.22 (para 3.03 and 3.13), while that of the company was $130,832.00.

3.17 Concerning the total investment of $113,510.58 alleged in paragraph 4 of the notice of appeal by appellant Mercerie Manic Inc., the respondent filed as Exhibit 1-15 a document showing investments for the appellant's fiscal years, that is, October 1 to September 30, 1977, 1978 and 1979.

3.17.1 Regarding 1977, there are two columns of figures, the second of them a list of deposits in the Canadian Imperial Bank of Commerce for those years. The first column lists figures that are smaller than those in the second column and are, according to the appellant, investments made at the same time as the deposits and included in the deposit figures. For example, on November 1, 1976, the deposit of $378.07 (column 2) included an investment of $126.75 (column 1). For most of these deposit entries, there is no indication of an investment. According to the appellant, the funds in question were from either Mastercharge charges or cheques already paid to the appellant.

Some lines show the follow information:

3.17.2 Regarding the appellant's 1978 fiscal year, the document contains only one column of 25 figures indicating deposits; each entry has a description, usually the name of a bank. In mostcases, the bank is the National Bank of Canada in Hauterive, the Bank of Montreal or the Royal Bank of Canada; the Royal Bank was where Hydro-Quebec deposited Mr. Cloutier's pay cheques (para 3.06.2). There are six entries that read “[translation] RB of Can (pay Albert)". Other descriptions are "[translation] NBC interest”, "[translation] Bank of Montreal Master Card" and “[translation] cash deposit". Deposits for 1978 totalled $53,652.58.

3.17.3 Regarding the 1979 fiscal year, there are only two entries: 3.17.4 The total for the three years is therefore $95,563.68.

3.18 The respondent also filed as Exhibit 1-4 a summary of the information taken from the financial statements of Mercerie Manic Inc. It should be remembered that the fiscal year end is September 30. Exhibit I-4 reads as follows [see page 2481]:

4. Act- Cases Cited-Analysis

4.1 Act

The main provisions of the Income Tax Act involved in this appeal are sections 3, 9 and 230 and subsections 15(1), 152(4) and 163(2), which will be cited in the analysis if necessary.

4.02 Cases Cited

The following cases were cited by the parties:

1. Shlien v. M.N.R., [1988] 1 C.T.C. 2244; 88 D.T.C. 1152 (T.C.C.)

2. Nesrallah v. The Queen, [1986] 1 C.T.C. 11; 85 D.T.C. 5585 (F.C.T.D.)

3. Pasnak v. M.N.R., [1984] C.T.C. 2719; 84 D.T.C. 1677 (T.C.C.)

4. Tobis v. M.N.R., [1981] C.T.C. 2161; 81 D.T.C. 125 (T.R.B.)

5. Ying v. M.N.R., 19 Tax A.B.C. 449; 58 D.T.C. 430

6. Urchyshyn v. M.N.R., [1971] Tax A.B.C. 307; 71 D.T.C. 234

7. Royal Crafts Products Ltd v. M.N.R., [1986] 1 C.T.C. 2290; 86 D.T.C. 1196 (T.C.C.)

8. Lemaire v. M.N.R., [1980] C.T.C. 2940; 80 D.T.C. 1808, (T.R.B.)

9. Venne v. The Queen, [1984] C.T.C. 223; 84 D.T.C. 6247 (F.C.T.D.)

10. Morin v. M.N.R., [1988] 2 C.T.C. 2334; 88 D.T.C. 1596 (T.C.C.)

11. Fortis v. M.N.R., [1986] 2 C.T.C. 2378; 86 D.T.C. 1795 (T.C.C.)

4.03 Analysis

There are three common points to be considered in the two appeals and raised by the two parties:

1. Is the additional income resulting from the assessment accurate? (4.04)

2. Was the Minister justified in reassessing the years 1977, 1978 and 1979, which were beyond the four-year period prescribed in subsection 152(4) of the Act? (4.05)

3. Were the penalties imposed under subsection 163(2) of the Act justified? (4.06)

4.04 Additional Income

4.04.1 To resolve the problem of the validity of the additional income determined by the respondent, we must examine the evidence relating to the points raised by the appellant, that is, the existence of a sum of $74,500 in May 1976 and investments of $113,500 in Mercerie Manic Inc. by the appellant through purchases of credit card slips and cheques and subsequent deposit of these amounts. And we must also examine the living expenses.

4.04.2(1) With respect to the $74,500 in cash that the appellant claims to have had in early 1976, the respondent, at the time of the notice of reassessment was issued, took into account $9,800 that the appellant allegedly had when Mercerie Manic Inc. began operating as a business in May 1976.

4.04.02(2) The evidence adduced by the appellant concerning the long-term and short-term sources of his assets from 1962 to 1982 is explained in paragraph 3.11 above, primarily through the appellant’s cash reconciliation (income less expenses) (Exhibit A-6).

According to that exhibit, at the end of 1975, the appellant had $169,722 in cash (para 3.11.3). Moreover, according to the respondent's calculations based on information obtained during the investigation, assets were $77,844.99 at September 3, 1976 (para 3.11.6).

At first glance, the difference of $91,878 ($169,722 — $77,844) leaves considerable room for an amount of $74,500 stashed in the refrigerator, even if we take into account the advances of $5,132 shown in the financial statements (para 3.18, Exhibit I-4) as made to Mercerie Manic Inc. between May 1976 and September 30, 1976. But the question remains whether the cash reconciliation in Exhibit A-6 is credible.

4.04.2(3) Several of the data in Exhibit A-6 are acknowledged and even confirmed by the respondent, namely the Hydro-Quebec wages, the interest (para 3.11.3, Exhibit 1-3), the appellant's loans to his brother ana the repayment (para 3.11.1) of those loans. However, do all these elements constitute sufficient evidence to allow the Court to conclude that the document is credible? Let us examine what the appellant said regarding the breakdown of the $74,500.

4.04.2(4) The $74,500 comprised $55,000 withdrawn from the National Bank of Canada in Manic in 1971-72 and $19,500 received in 1973 as a settlement for an accident (para 3.11.5). While the $19,500 can be located in Exhibit 1-6, the $55,000 could not be confirmed by any bank documents (para 3.11.5). No other person came forward to testify as to the existence or amount of the hidden money.

There is also the appellant's evidence of his plans to hide money beginning in 1971-72 (when he was thinking of starting his own business) so that he would not lose everything if the business went bankrupt (para 3.12). This statement raises serious doubts about the credibility of the appellant's testimony and the documents he prepared. And there is another side to this statement as well. The candour with which the appellant told the court of his primary objective of hiding money indicates to me that he would not have invented it if it were not in fact true. The disadvantageous situation such an admission of dishonest intent places the appellant in was not worth the trouble of inventing the existence of a cash reserve.

While this statement does indicate the existence of some amount of cash, it does not prove how much. Most of the $74,500 was comprised of $55,000 withdrawn from the bank in 1971. Is this only mathematically plausible? The appellant's wages between 1962 and 1970 totalled $80,313 (Exhibit A-6). If we consider that at the time of his marriage he already had some assets (para 3.11.1), the total amount in 1970 could then be between $90,000 and $100,000. It is therefore mathematically plausible in theory that in 1971, he had $55,000 in the bank.

4.04.2(4) Is the fact that this is mathematically plausible sufficient evidence for the Court to believe that this $55,000 was "frozen" for the intended purpose, just as the $19,500, even though traces of its existence are found in Exhibit A-6?

As an individual, I would be inclined to allow substantially more than the amount allowed by the respondent. As a judge, however, subject to the principle of best evidence, and especially in a case of this type where the credibility of the witness is tainted with respect to the whole of his evidence, I can only uphold the respondent's decision, as no strong and more direct confirmation of the actual facts was made.

4.04.2(5) In any event, even if the evidence as to the existence of a liquid fund of $74,500 in 1976 were clear, this would not explain all of the $128,000 in additional income on which the notice of reassessment were based. There is an unexplained balance of approximately $63,000, taking into account that in establishing the said notices of reassessment, the respondent accepted the existence of a liquid amount of $9,800.

4.04.3 An investment of $113,500 in Mercerie Manic Inc.?

4.04.3(1) According to the appellant, his investments in Mercerie Manic Inc were in the form of purchases of Mastercharge slips and cheques and direct deposits into the company account of money from the cashing of credit card slips and cheques and also from wages, interest, etc.

4.04.3(2) Regarding the financing of credit card slips, the system is described in paragraphs 3.07.1(a) through 3.07.1(g) in connection with purchases of merchandise in 1982. While it was not often used, the system is understandable and explainable, although there is one unanswered question arising from the deposit of June 4, 1982, which does not include at least $173,00 in cash, that is, the amount of the credit card slips purchased ($165 and $8) (para 3.07.1(c)).

The system seems to be confirmed by the deposit of the said purchased credit card slips into the Bank of Montreal account (Exhibit A-5) between 1977 and 1982. The total amount of these deposits, including those in Exhibit I-10, is $25,655.88 (para 3.07.1(h)).

The truthfulness of the system does not, however, permit a finding that this explains, at least in part, the additional sales determined by the respondent for both the appellant and Mercerie Manic Inc. In paying Mercerie Manic Inc. (the deposits in the Canadian Imperial Bank of Commerce show that total sales did not change), the amount that appears on the deposit slip is the same as the amount on the cash register tape and in the cash/receipts book (Exhibit A-4), at least in the examples given in detail in paragraph 3.07.1, provided, of course, that all the income was recorded on the cash register tape and in the cash/ receipts book.

Mr. Bouchard, who prepared Exhibit 1-10, told us that $4,000 was apparently withdrawn from this account in 1978 as an investment in Mercerie Manic Inc. and that transfers were made to the appellant's personal bank account in the amounts of $2,000 in 1979, $5,000 in 1980 and $2,000 in 1981 (par 3.07.(i)). It appears that at least $13,000 ($4,000 + $5,000 + $2,000 + $2,000) was withdrawn from this account and used for a purpose other than to purchase credit card slips or cheques.

But before we draw any conclusions, let us examine the purchase of cheques and the analysis of the evidence regarding the other investments.

4.04.3(3) The evidence related to the purchase of cheques showed the existence of a mechanism similar to the one for credit cards but no evidence of the size of the amount used for this purpose (para 3.07.2).

4.04.3(4) Exhibit I-15, the key exhibit relating to the appellant's investments in Mercerie Manic Inc. and explained in paragraphs 3.17 through 3.17.4, shows, as does Exhibit 1-10, that in 1978, the appellant invested $4,000 in Mercerie Manic Inc. It appears from Exhibit 1-15 that the following amounts were invested in Mercerie Manic Inc:

$1,200 on 06/01/78

$ 400 on 10/02/78

$ 900 on 17/04/78

$ 900 on 13/06/78

$ 600 on 01/08/78

TOTAL $4,000

According to Exhibit 1-15, total investments in 1977, 1978 and 1979 were $95,563.68 (para 3.17.4). Let us compare this figure with the figures in Exhibit I-4 summarizing the information taken from the financial statements of Mercerie Manic Inc. (para 3.18). It appears that the total advances to Mercerie were as follows:

If we subtract from the $108,510 (cumulative in 1979) $5,132 for 1976, it then appears that in 1977, 1978 and 1979, the appellant advanced Mercerie Manic Inc. $103,468. Another consideration is that if the appellant had $74,500 in cash, this means that around June 1978, the entire cash reserve in the refrigerator had been withdrawn, if, of course, the appellant used it exclusively to invest in Mercerie Manic Inc., either directly or indirectly with the money deposited for credit card slips and cheques.

4.04.3(5) All the notices of reassessment are based on the unexplained differences in capital between the end of December 1976 and the end of December 1982. According to the respondent, the main explanation is funds obtained from Mercerie Manic Inc. through unreported sales. We should, therefore, analyse the facts adduced as evidence regarding the argument.

Mr. Bouchard testified that one of the striking facts regarding the income of Mercerie Manic Inc. is that in 1978, the company had gross profits of only 5 per cent. Using the financial statements of Mercerie Manic Inc., percentage gross profit was first calculated for each year as shown in Table 1 below.

Percentage gross profit was then calculated using the additional income that the respondent added to the income of Mercerie Manic Inc., these results are shown in Table II below.

Table I

Mercerie Manic Inc.

Operating Results and Cumulative Deficit (Unaudited)

for the Period Ending September 30

	1977 1978			1979	1980	1981	1982
Sales	$144,744 $174,267 $151,931 $151,931 $162,783 $163,692
$164,019
Cost of Sales	86,507		166,390	95,902	92,729	105,832	106,123
Gross Profit*	28,237		7,877	56,029	70,054	57 ,860	"57,896
Operating
Expenses	28,703		36,163	40,177	53,725	69,532	43,356
Operating
Expenses
Net Loss	(	466)	(28,286)	15,582	16,329	(11,672)	14,540
Accumulated
Deficit at
Start of Year	(13,385)		(13,851)	(42,137)	(26,285)	(9,956)	(21,628)
Accumulated
Deficit at
End of Year	(13,851)		(42,137)	(26,285)	(9,956)	(21,628)	(7,088)

NB: Gross profits in percentages for the years in questions:

*Gross Profit
(%)	24.6%	4.52%	36.87%	43%	35.34%	35.2%

		Table Il
	1977 1978		1979 1980 1981 1982
Reported Sales	$114,744 $174,267 $151,931 $162,931 $163,692 $164,019
Additional Sales
not Reported	16,998	40,055	36,840	16,795	12,544	7,598
Total Sales	131,742 214,322 188,771 179,726 179,726 171,617
Cost of Sales	86,507 166,390 95,902 92,729 105,832 106,123
Adjusted Gross
Profits	45,235	47,932	92,869	86,997	70,404	65,494
Adjusted Gross
Profits (%)	34.33% 22.36% 49.19% 48.40% 39.94% 38.16%

It may be useful to remember that the missing pieces in the taxpayer's accounting system are sales invoices. The additional income must therefore be added in calculating gross income. Business expenses were not questioned in the reassessments.

Indeed, no evidence was adduced to indicate the normal net profit in the sector in which Mercerie Manic operated.

4.04.3(6) Counsel for the appellant referred to Shlien (para. 4.02(1)), in which an amount of $62,500 was added to Ms. Shlien's income. Chief Justice Couture of this Court dismissed the respondent's claim because there was nothing that might explain that the said amount could have been generated by any source of income. The Court instead accepted the version whereby the amount in question was given to her by her brother-in-law when the taxpayer was visiting East Germany and the amount was an amount that the taxpayer's late husband had given to her brother-in-law for him to return to her.

In the absence of evidence showing that the amount in question is from a source of income, which would explain the increase in the appellant's net worth and support the basis on which the assessment was made, or that it is reasonable to assume that the amount could have been derived from such a source, I have no other choice but to accept what she said regarding the source of this additional capital in the taxation year in question.

[Emphasis added]

In the present appeal, there is one source which can explain the additional income, namely Mercerie Manic Inc., unless the appellant proves that the percentage gross profit taking into account the additional unreported income is inconsistent with the true situation in business.

4.04.3(7) Having analysed the appellant’s living expenses as determined by himself and the respondent on several occasions, each making his own concessions at the end, as shown in paragraph 3.15, I have reached the following conclusion: divide in half the difference for the years 1977 through 1982. This gives the following final figures for these years:

4.05 Is the Minister justified in reassessing the years 1977, 1978 and 1979, which are beyond the four-year period prescribed in subsection 152(4) of the Act?

Subsection 152(4) reads:

152.(4) The Minister may at any time access tax, interest or penalties under this Part or notify in writing any person by whom a return of income for a taxation year has been filed that no tax is payable for the taxation year, and may

(a) at any time, if the taxpayer or person filing the return

(i) has made any misrepresentation that is attributable to neglect, carelessness or willful default or has committed any fraud in filing the return or in supplying any information under this Act, or

(ii) has filed with the Minister a waiver in prescribed form within 4 years from the day of mailing of a notice of an original assessment or of a notification that no tax is payable for a taxation year.

(b) within 4 years from the day referred to in subparagraph (a)(ii), in any other case, reassess or make additional assessments, or assess tax, interest or penalties under this Part, as the circumstances may require.

The respondent's claim is that the appellant failed to include in his income. approximately $128,000, including approximately $85,000 in the years 1977, 1978 and 1979, all such income apparently derived from Mercerie Manic Inc. The appellant was unable to reverse the burden of proof on him. And furthermore the only possible source of this $85,000 in additional income was in fact Mercerie Manic Inc, the company of which the appellant was the principal shareholder, president, director and manager, and the said company kept neither sales invoices nor even cash register tapes for the years 1977,1978 and 1979. At the very least, no such tapes for the three years in dispute were produced as evidence^] regarding the years 1980, 1981 and 1982, although there were cash register tapes, there were no sales invoices.

While it was proven that the accounting system included a receipts book, an expenses book, a deposit book, a general ledger and cash register tapes beginning in 1980 (para 3.08), there is still one fact that must be considered: since no audit could be done with sales invoices, additional income was assessed for both Mercerie Manic Inc. and Mr. Cloutier. It is unthinkable that a business, whether incorporated or not, whose primary objective is to make money would not keep sales invoices. The sales invoice is essential in proving that a sale was made. Section 230 of the Act requires businesses to keep all documents that “will enable the taxes payable to be determined".

An accountant prepared the appellants' tax returns and financial statement. Either Mr. Cloutier did not follow his advice or the accountant was incompetent. It can probably be said that legally, a corporation is a legal entity separate from its shareholders and that Mr. Cloutier did not have to be affected if Mercerie Manic Inc. was reassessed for the years 1977, 1978 and 1979 for additional income of more than $93,000. Mr. Cloutier, who is the principal shareholder, president, director and manager of the company, again could not, according to the balance of evidence, show that the additional income added to the income reported by him personally was not from Mercerie Manic Inc.

The negligence referred to in subsection 152(4) therefore applies to both Mr. Cloutier and Mercerie Manic Inc. The respondent was entitled to reassess the two appellants for the years 1977,1978 and 1979.

I would like to point out that perhaps the evidence could have been more thorough in that some additional documents and witnesses could have considerably altered the notices of reassessment. The Court must, however, base its decision on the evidence laid before it and not the evidence that might have been adduced.

4.06 Penalties

Are the penalties imposed under subsection 163(2) justified?

Subsection 163(2) reads:

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 false statement or omission in a return, form, certificate, statement or answer (in this section referred to as a "return") filed or made in respect of a taxation year as required by or under this Act or a regulation, is liable to a penalty of

(a) 25% of the amount, if any, . . . .

For reasons similar to those given above with respect to subsection 152(4), I find that there is justification for at least a charge of gross negligence because of the substantial amount of income involved and that the entire matter is due to the total absence of sales invoices. The penalties are upheld in both appeals. Of course, the reduction in income resulting from the decision on Mr Cloutier's living expenses may affect the penalties.

5. Conclusion

The appeal is allowed in part, and the matter is referred to the respondent for further review and reassessment.

Appeal allowed in part.