Cassidy's Limited (Formerly Packer Floor Coverings Ltd.) v. Minister of National Revenue, [1990] 1 CTC 2043

Rip, T.C.J.: —During the years 1980 to 1984 Packer Floor Coverings Ltd. ("Packer"), [1] at the time a wholly owned subsidiary of the appellant, incurred losses as a result of frauds committed by its vice-president. In computing its income for those years Packer claimed the losses as non-capital losses the deduction of which were not prohibited by section 18 of the Income Tax Act ("Act") but the Minister of National Revenue, the respondent, reassessed Packer on the basis the losses were capital losses and therefore not deductible in computing income. The appellant appeals from reassessments for the 1980 and 1981 taxation years and from determinations of non-capital losses for the 1982 and 1983 taxation years when Packer’s tax was assessed as nil.

Preliminary Matter

In his reply to the notice of appeal the respondent alleged that he assessed Packer nil federal tax for 1981 and therefore this Court is without jurisdiction to hear the appeal for the 1981 taxation year. Counsel for the appellant submitted that while the respondent did in fact assess Packer no federal tax for 1981, he did assess Packer interest for 1981. In assessing 1981, counsel explained, the respondent disallowed a non-capital loss claimed in the amount of $139,983 but allowed a non-capital loss of $33,053 pursuant to section 111 of the Act. The appeal is a proper appeal because if the appellant is successful interest will have to be recalculated on instalments of taxes paid by the appellant, taking into account income for the year rather than computing instalment interest on a loss carry back basis.

Section 152 of the Act provides that the respondent shall ”. . .assess tax for the year, the interest and penalties, if any, payable. . .". As counsel stated, the assessment includes not only tax but also interest. What may be appealed therefore is not only tax, but interest and penalties as well. Subsections (2) and (7) of section 161 describe how interest on instalments of tax is calculated when a taxpayer fails to make an instalment. To determine the interest on instalments payable by a taxpayer the respondent must take into account the amount of any non-capital losses incurred by the taxpayer, in the year. Counsel for the respondent has since advised the Court that his client is now of the view that the appeal is valid and I agree.

Facts

Mr. Jack A. O'Hanley, an officer of the appellant, Cassidy's Ltd. ("Cassidy's"), was the only witness at the hearing of these appeals. He described Cassidy's as an old Quebec company now having its head office in Toronto, carrying on the restaurant supply business across Canada. Cassidy's was, and is, a public corporation controlled by the Brodeur family. Cassidy's acquired Packer and Imbrex-Cassidy Ltd. ("Imbrex"), both companies in the floor covering distribution business, in 1974. Imbrex carried on business in the Atlantic provinces and Packer in Quebec. Packer's head office during the years in appeal was in Montreal.

In 1978 the officers of Packer included Mr. Patrick Brodeur, president, Mr. R. Faubert, vice-president, Mr. O'Hanley, vice-president, responsible for Cassidy's floor covering division and Richard Rochefort, secretary-treasurer. Mr. O'Hanley had authority for Packer in certain areas which were not described.

Packer also had four directors who appear to have been its officers. However, Mr. O'Hanley stated no meetings of directors of Packer were ever held.

Besides carrying on a business Cassidy's owned several operating subsidiaries during the years in appeal. The rules for the operation of each subsidiary, including Packer, were determined by Cassidy's directors. Many of the rules were not in writing. Each year the operating officer of each subsidiary would meet Mr. Brodeur and Cassidy's controller to establish a budget for the upcoming fiscal year. Monthly, each subsidiary or division would compile results for that month's operations and send reports to Mr. Brodeur in Toronto. All subsidiaries and divisions reported on the same basis for ease of comparison. The reports which included accounts receivable, accounts payable and monthly budgets were reviewed carefully at head office level, according to Mr. O'Hanley.

The head of each subsidiary and division was responsible for the monthly results. If the monthly profits were satisfactory the division would hear nothing from head office.

Mr. Rochefort, a chartered accountant, was originally engaged as Packer's controller. He was responsible for accounting procedures, systems and cheques. Mr. Faubert was originally responsible for the overall operation of the floor covering business but Mr. Rochefort took over these responsibilities in 1981.

Mr. Rochefort reported to Cassidy's controller in Toronto and to Mr. Brodeur, the former with respect to finances and the latter with respect to general operating matters and serious financial problems. According to Mr. O'Hanley, Mr. Rochefort would probably have sought advice from Mr. Brodeur as and when required. He added that Mr. Rochefort should have reported to him as well but did not.

Mr. O'Hanley described Mr. Brodeur as a "hands on" manager of all the operating companies in the Cassidy group. This was true, he said, in 1978, the years in appeal and today. Mr. Brodeur visits Montreal regularly, for example, to check on Packer's operations. Mr. O'Hanley, a vice-president of Imbrex, which had a better profit than Packer, was directed by Mr. Brodeur in 1978 to supervise Packer's operations; he visited Montreal monthly to look into Packer's operations and to make suggestions to Mr. Faubert as to how Packer could be operated more profitably.

In 1978 Packer employed approximately 50 people and had facilities in Montreal and Quebec City.

Appellant's counsel led evidence in an attempt to demonstrate that notwithstanding the distinct corporate status of Packer during the years in appeal, Packer ought to be considered as a division of Cassidy's. Evidence was also led to contrast Packer's assets and sales to those of all companies in the Cassidy group to demonstrate the relatively minor role of Packer in the overall consolidated operation of Cassidy's and its subsidiaries. For example, Packer's assets at the end of 1981 were $6,870,000 compared to all of the groups assets of $42,358,000 in 1981. Packer's gross sales for 1981 were 15,031,000 compared to the group's sales of $90,941,000.

During the autumn of 1981 Mr. Rochefort was promoted to vice-president and general manager of Packer. By employment agreement dated October 29, 1981, he retained his previous function as controller and was also given "complete discretion over (Packer's) distribution in Eastern Canada”. His "complete discretion” included the financial operations of Packer.

Mr. O'Hanley continued to visit Montreal to assist Mr. Rochefort. Cassidy's controller in Toronto, Mr. Ryan, was responsible for consolidating the monthly reports and to ensure the subsidiaries, including Packer, followed generally accepted accounting principles (“GAAP”) in preparing their reports. According to Mr. O'Hanley, Mr. Ryan "keenly kept an eye on expenses" together with Mr. Brodeur.

As the person responsible for Packer's financial operations, Mr. Rochefort appeared as a witness for Packer in litigation. He also obtained two contracts from suppliers, who eventually ceased carrying on business, but which later proved very advantageous to Packer. Packer’s income tax returns were signed by Mr. Rochefort. Cheques issued by Packer required his signature together with one of two other employees.

Mr. O'Hanley described Mr. Rochefort as ”. . .very personable. . .had a dignity to him. . .a chartered accountant. . .knowledgeable and presented himself well . . . could not say anything against him until we started having problems with him. . . not afraid of work . . . worked hard and well. . .".

In October 1982, at a meeting of Cassidy subsidiary and division heads in Toronto, Mr. Rochefort indicated that Packer would report a loss of $400,000 for its 1982 fiscal year. When the 1982 fiscal year was closed the loss was determined to be $1,500,000. Head office personnel questioned how a $400,000 loss predicted in October could reach $1,500,000 two months later. Mr. Rochefort was dismissed from employment “for cause" on March 14, 1983.

Mr. O'Hanley was sent to Montreal to get Packer in a profitable position. Mr. O'Hanley took with him to Montreal the controller of Imbrex to do “investigation work". Mr. O'Hanley sought to determine where lost profit disappeared and to this end ordered tests performed. Mr. O'Hanley and the Imbrex controller reviewed the account of a supplier which yielded Packer a gross profit of 11 per cent which was considered low; Mr. O'Hanley estimated Packer's gross profit from this particular supplier ought to have been 17 per cent to 18 per cent. Complaints were made to the supplier that the low profit margin did not warrant retaining his business. The supplier objected to Packer's position and its president met with Mr. O'Hanley to discuss the matter. Prior to the meeting the supplier was asked to bring its own statements with Packer for the 12 months of 1982. Packer completed a list of all cheques payable to the supplier in 1982. At the meeting it was determined Packer had paid the supplier more than the latter was owed. On reviewing cheques it was found that while many of the cheques were charged to this supplier, the cheques were not made out ot the supplier but, for example, to the Canadian Imperial Bank of Commerce for payment of Mr. Rochefort's Visa account. It was soon discovered this practice had been repeated with other suppliers as well.

The Canadian Imperial Bank of Commerce was Packer's banker as well as Mr. Rochefort's banker. Mr. Rochefort took advantage of this and on many occasions would issue Packer cheques to the bank, ostensibly for the company's operations, but in reality for payment of his personal debts including amounts he owed to the bank. Other cheques were issued by Packer to a company controlled by Mr. Rochefort and to other persons with whom Packer had not done any business and to whom it owed no money. Certain cheques were prepared by the Packer bookkeeper on instructions from Mr. Rochefort with no supporting source documents such as invoices; rather she would receive a handwritten cheque voucher prepared by Mr. Rochefort listing only the payee, the dollar amount and the account code to be charged. In other instances Mr. Rochefort took advantage of the arrangement Packer had with the bank for payment to United States suppliers. Packer would send money to the bank to pay freight and customs duty on imported merchandise for payment. Mr. Rochefort would cause cheques to be issued to his account, charging them to cost of goods.

Once these irregularities had been discovered Mr. Brodeur and the secretary-treasurer of Cassidy's were informed. The company’s auditors, a national firm of chartered accountants, were called in to perform a detailed review of Packer's disbursements for 1981, 1982 and 1983 and to investigate apparent discrepancies between purchases recorded by Packer and sales reported by its major suppliers. Later on the review was extended from January 1, 1978 to the date of Mr. Rochefort's dismissal.

Mr. O’Hanley testified that Packer's gross profit was usually two per cent to three per cent lower than that of Imbrex, although both were in the same business. The lower profit had been justified in the past to the cost of doing business in Quebec, a more conservative area requiring merchandise to be sold at a lower margin. However, Mr. O'Hanley volunteered it could have been theft. Packer's accounts were audited each year without the auditor finding any indication of false cheques.

During the years in appeal Mr. Rochefort caused Packer to issue cheques for his benefit in the amount aggregating $454,264, as follows:

The evidence indicates that Mr. Rochefort first started his illegal activities when he drew a cheque payable to the Canadian Imperial Bank of Commerce in the amount of $1,188.46 on January 30, 1978. Mr. Rochefort was a bonded employee and Packer has recovered $180,000 from the insurer. [2] Packer also recovered funds from its former auditor. Action was also taken against Mr. Rochefort who, although he declared bankruptcy, has some assets and Cassidy's is hopeful of recovering money from him.

Parties' Submissions

Subsection 9(1) of the Act provides that, subject to Part I of the Act, “a taxpayer's income for a taxation year from a business or property is his profit therefrom for the year”. The appellant says the losses suffered by Packer as a result of Mr. Rochefort's defalcations are deductible in computing Packer’s profit from a business and are not prohibited by virtue of any provisions of the Act.

The respondent's view is that the losses were non-deductible expenses resulting from the actions of a senior employee of Packer and did not constitute expenses incurred for the purpose of earning or producing income from a business within the meaning of paragraph 18(1)(a) of the Act, which reads as follows:

18(1) in computing the income of a taxpayer from a business or property no deduction shall be made in respect of

(a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property.

In assessing in the manner he did, the respondent followed assessing policy enumerated in his Interpretation Bulletin IT-185, dated November 4, 1974:

1. A loss of trading assets such as stock in trade or cash through theft, defalcation or embezzlement normally is allowed as a deduction in computing income where a taxpayer's business involves this risk. In determining whether such a loss is allowable the Department uses the following guidelines.

2. Loss through

(a) theft, holdup or robbery by a stranger, or

(b) theft, defalcation or embezzlement by an employee, unless he is a senior official or a major shareholder,

is allowed, Loss through theft, defalcation or embezzlement by a partner is not allowed.

At the commencement of the trial counsel advised the Court that they agreed for purposes of these appeals at bar and subject to relevancy, generally accepted accounting principles ("GAAP") recognize the "amounts in issue would have been taken into account in computing profit”. If I understand the respondent's counsel, he does not conclude, as does the appellant's counsel, that the amounts stolen would have affected the determination of profit. In my view the relevant amounts would have been deducted from revenues for the year to determine that year's profits in accordance with GAAP.

Analysis

The right to claim a deduction pursuant to subsection 18(1)(a) has been discussed in numerous cases over the years. Madame Justice Wilson, delivering judgment in the Supreme Court of Canada, quoted with approval the following comments of President Thorson of the Exchequer Court of Canada in Royal Trust Co. v. M.N.R., [1956-60] Ex. C.R. 70; [1957] C.T.C. 32, at pages 43 and 44 in Mattabi Mines Ltd. v. Ontario (Minister of Revenue), [1988] 2 S.C.R. 175; [1988] 2 C.T.C. 294 at page 300 (S.C.R. 186):

The essential limitation in the exception expressed in Section 12(1)(a) is that the outlay or expense should have been made by the taxpayer "for the purpose” of gaining or producing income “from the business”. /t is the purpose of the outlay or expense that is emphasized but the purpose must be that of gaining or producing income “from the business" in which the taxpayer is engaged. If these conditions are met the fact that there may be no resulting income does not prevent the deductibility of the amount of the outlay or expense. Thus, in a case under the Income Tax Act if an outlay or expense is made or incurred by a taxpayer in accordance with the principles of commercial trading or accepted business practice and it is made or incurred for the purpose of gaining or producing income from his business its amount is deductible for income tax purposes.

[Emphasis added.] [3]

In Johns-Manville Canada Inc. v. The Queen, [1985] 2 S.C.R. 46; [1985] 2 C.T.C. 111; 85 D.T.C. 5373, Estey, J. stated at page 123 (D.T.C. 5382) that:

. . .if the interpretation of a taxation statute is unclear, and one reasonable interpretation leads to a deduction to the credit of a taxpayer and the other leaves the taxpayer with no relief from clearly bona fide expenditures in the course of his business activities, the general rules of interpretation of taxing statutes would direct the tribunal to the former interpretation.

Jackett, P. (as he then was) explained the steps required to determine a taxpayer's income for the year from a business in his reasons for judgment in Associated Investors of Canada Ltd. v. M.N.R., [1967] C.T.C. 138; 67 D.T.C. 5096 at pages 143-44 (D.T.C. 5098 and 5099):

Under the Income Tax Act, in determining the income tax payable by the appellant for a year, the first step is to determine the “income” from the appellant's business for the year (Section 3). Subject to any special provision that may be applicable the “income” from a "business" for a year is the "profit" therefrom for the year (Section 4)

Profit from a business, subject to any special directions in the statute, must be determined in accordance with ordinary commercial principles. The question is ultimately "one of law for the Court”. It must be answered having regard to the facts of the particular case and the weight which must be given to a particular circumstance must depend upon practical considerations. As it is a question of law, the evidence of experts is not conclusive.

My first task is therefore to determine the proper treatment of the amounts in question in accordance with ordinary commercial principles. Having ascertained that, I must consider whether any different treatment is dictated by any special provision of the statute.

Ordinary commercial principles dictate, according to the decisions, that the annual profit from a business must be ascertained by setting against the revenues from the business for the year, the expenses incurred in earning such revenues.

In considering whether the results of any transaction can be considered in computing the profit of a business for a particular year, the first question is whether it was entered into for the purpose of gaining or producing income from the business. If it was not, such results cannot be taken into account in computing such profits. Even if the transaction was entered into for the purpose of the business, if it was a capital transaction, its results must also be omitted from the calculation of the profits from the business for any particular year.

Upon reviewing jurisprudence with respect to the relevance of GAAP to provisions of the Act in The Queen v. Metropolitan Properties Co. Ltd., [1985] 1 C.T.C. 169; 85 D.T.C. 5128, Walsh, J. concluded, at pages 180-81 (D.T.C. 5137):

1. General Accepted Accounting Principles (GAAP) should normally be applied for taxation purposes also, as representing a true picture of a corporation’s profit or loss for a given year.

2. By exception they need not be applied for income tax purposes if there is some section or sections in the Income Tax Act which justify or require a departure from them or do not correspond with what are commonly accepted business and commercial practices.

5. The fact that there is nothing in the Income Tax Act to prevent such deductions from being treated as current expenses and deducted as such from income in the year in which they are made is not sufficient justification for departing from GAAP principles in dealing with them in this way. It is the converse argument which should be adopted to the effect that these principles should only be departed from if something in the Act specifically requires or authorizes this. Parliament has addressed itself to and dealt with the treatment to be given to other types of developers' expenses but has not specifically dealt with the type of expenses with which we are concerned here, and failure to do so results in the desirability of applying generally accepted commercial and business practice as reflected in the GAAP principles.

Counsel for the respondent has not referred the Court to any provision in the Act which specifically accords a different treatment of the amounts in issue from GAAP or which otherwise prohibits the deduction of the amounts, except that counsel says the losses are capital expenditures or losses. Counsel for the appellant did argue that the amounts deducted were reasonable in the circumstances and therefore not prohibited by section 67 of the Act. The respondent did not raise the issue that the expenses were not reasonable and accordingly that issue need not be addressed in these appeals. However, if amounts stolen are otherwise deductible in computing income, one would normally assume that the losses from the defalcation were reasonable deductions in the circumstances.

Counsel for the respondent strongly argued that Mr. Rochefort was a senior employee of Packer. Although Mr. Rochefort reported on a regular basis to the head office of Cassidy's on the operations of Packer, he in fact managed and ran Packer's operations. The office he held as vice-president of Packer held him out to the public as a responsible senior employee of Packer. He was also a director of Packer. I agree with counsel and find that Mr. Rochefort was indeed a senior, if not the senior, employee of Packer during the years in appeal. However, I cannot agree with counsel for the respondent, and the respondent himself, as published in Interpretation Bulletin IT- 185, that simply because a theft or defalcation was committed by a senior employee, the losses resulting from such a commission are not deductible by the employer in computing income for tax purposes.

Several cases were cited to the Court by the respondent's counsel in support of his submission. In Bamford (Inspector of Taxes) v. A. T.A. Advertising Ltd., [1972] 3 All E.R. 535, one of the taxpayer company's directors and owner of 50 per cent of the shares of the company fraudulently embezzled £15,000 from the company by way of drawing cheques on the company bank account to another corporation he controlled. The Court, Chancery Division, disallowed the deduction of the £15,000 since the loss could not be fairly regarded as a loss "connected with or arising out of the trade". The Court stated that where a director with authority to sign cheques appropriated large sums which were then lost to the company there was no relevant nexus between the loss of money and the conduct of the company's trade. Brightman, J. explained the distinction between the petty theft by a subordinate employee and a massive defalcation by a director:

I can quite see that the commissioners might find as a fact that a £5 note taken from the till by a shop assistant is a loss to the trader which is connected with and arises out of the trade. A large shop has to use tills and to employ assistants with access to those tills. It could not trade in any other way. That, it seems to me, is quite a different case from a director with authority to sign cheques who helps himself to £15,000, which is then lost to the company. I find it difficult to see how such a loss could be regarded fairly as “connected with or arising out of the trade". In the defaulting director type of case, there seems to me to be no relevant nexus between the loss of the money and the conduct of the company's trade. The loss is not, as in the case of the dishonest shop assistant an incident of the company's trading activities. It arises altogether outside such activities. That, I think, is the true distinction.

In Ash v. Federal Commissioner of Taxation, [1938] 5 A.T.D. 76, the Australian Court disallowed the losses of amounts defalcated by a partner to be deducted from the income of the partnership. Latham, C.J. stated at page 79:

Thus, purlongings [sic] by office boys and thefts by shop employees should prima facie, be allowed as deductions. They may be shown to be incidental to, and perhaps inevitable in, the operations which produce income.

But the case is different when income is actually received and then misapplied by the proprietor of a business or a person in the position of such a proprietor, as, for example, the manager of a company.

In Curtis (H.M. Inspector of Taxes) v. J. & G. Oldfield, Ltd., [1925] 9 T.C. 319, the managing director of a company of wine and spirit merchants was for many years, up to his death in 1919, in sole executive control of the company's business; he was also a minority shareholder of the company. An investigation after his death showed that many payments and some receipts not relating to the company’s business but to his private affairs had been passed through the company's books, and it was calculated that some £14,000 was due from his estate to the company. The debt was valueless and was written off as a bad debt in the company's accounts. Mr. Justice Rowlatt of the High Court of Justice found the loss was not a trading loss and was not an admissible deduction for tax purposes. Rowlatt, J. stated, at page 331, that:

. . .assets of the Company, moneys which the Company had got and which had got home to the Company, got into the control of the Managing Director of the Company, and he took them out. It seems to me that what has happened is that he has made away with receipts of the Company dehors the trade altogether in virtue of his position as Managing Director in the office and being in a position to do exactly what he likes.

In Canada the Income Tax Appeal Board dismissed an appeal by a corporation who discovered its general manager had diverted $36,000 of the corporation's funds for his own purposes. The operation of the business was left entirely in the general manager's hands and none of the other directors interfered in any way. The Board held the loss was not deductible from its income since it was not a loss incurred in the ordinary course of business. The money involved had already been earned and was in the company's coffers. The general manager removed the money by an improper exercise of the unfettered control he possessed. His actions had nothing to do with the company's income earning activities: General Stampings of Canada Ltd. v. M.N.R., [1957] Tax A.B.C. 1; 57 D.T.C. 163.

Where the money involved had already been earned, the sums appropriated by the company's manager, who was a shareholder and director and was completely in charge of the company's receipts, were held by the Tax Appeal Baord not to be deductible in computing income since the loss did not occur in the ususal course of the company's business and was not related to the earning of its income: Blue Bonnet Oil Co. v. M.N.R., 20 Tax A.B.C. 73; 58 D.T.C. 487. The Board also dismissed an appeal where the amounts were stolen or misappropriated by a senior official on the basis the stolen amounts were a “loss of capital”: Dessin General Drafting Inc. v. M.N.R., [1968] Tax A.B.C. 327; 68 D.T.C. 239 but allowing an appeal where the amounts were stolen by a subordinate employee: Royal Holdings Ltd. v. M.N.R., [1969] Tax A.B.C. 1169; 69 D.T.C. 775. A loss through theft by a partner was denied by the Board as a deduction in computing income: Miller v. M.N.R., 8 Tax A.B.C. 385; 53 D.T.C. 266, Cameron v. M.N.R., 21 Tax A.B.C. 193; 59 D.T.C. 64.

The respondent agreed a corporation may deduct funds misappropriated by a trusted employee over 25 years. The only issue at trial was in what taxation year the losses were deductible: Montreal Bronze Ltd. v. M.N.R., 29 Tax A.B.C. 345; 62 D.T.C. 371. Amounts stolen by employees in the employer's usual course of business operations were held by the Income Tax Appeal Board to be deductible: Thayer Lumber Co. Ltd. v. M.N.R., 18 Tax

A.B.C. 284: 58 D.T.C. 48 and Weidman Brothers Limited v. M.N.R., 2 Tax A.B.C. 223; 50 D.T.C. 322.

An individual who is a shareholder in a corporation has a proprietary interest, albeit indirect, in the corporation. In almost all the cases respondent's counsel cited to me in support of the principle that amounts of theft or defalcation by a senior employee are not deductible in computing income, the senior employee was a director and shareholder of the employer: Curtis, op. cit., Bamford, op. cit., Blue Bonnet Oil Co., op. cit., and Dessin General Drafting Inc., op. cit. ; in other cases the embezzler was a partner: Cameron, op. cit., and Miller, op. cit. Only in General Stampings, op. cit., where the general manager controlled the business without any interference from other directors, was he not a shareholder. The defalcations were not necessarily thefts by a simple employee but by persons who were directors and shareholders who had, or were permitted to act as if they had, a proprietary interest in the business and took advantage of their position. On this fact alone, the appeal at bar may be distinguished from these cases.

A theft by an employee may be petty theft, for example, when an employee steals money from a till or some merchandise from a counter. The theft also may be potentially significant when, for example, a trusted employee draws cheques from his employer's bank account for his own benefit or when an employee embezzles funds from his employer by means of computer technology. The employee who shoplifts may be the most subordinate employee or the president of the employer; the employee falsifying cheques or operating the computer may be a middle level employee. Should a distinction in the degree or level of employment make a difference as to whether the employee theft is deductible by the employer in computing its income? The case law distinguishes not so much as to the level of the employee in the employer's hierarchy but how and at what stage in the income earning process the money is stolen or embezzled. Whiteman and Wheatcroft on Income Tax, [4] at page 383, suggests that notwithstanding the decision in Bamford, op. cit.,

. . .there may be instances in which a director's defalcations may be deductible. It is clear that if a director with power to draw cheques merely siphons money out of the company’s bank account, that has nothing to do with the trade. But if, for example, the managing director defrauds his company by supplying false invoices to one of the company's suppliers, the money embezzled would seem to be just as much lost in the course of the company's trade as if the goods invoicing clerk had been the guilty party.

The Supreme Court of New Zealand considered a case where a company deducted losses incurred by theft by a senior employee in computing its income: W.G. Evans & Co. Ltd. v. Commissioner of Inland Revenue, [1976] 1 N.Z.L.R. 425. The facts are described in the headnote:

K, a practising accountant, who held 100 shares out of a total shareholding of 10,000, was employed by the objectors as secretary. K was subsequently appointed a director of the objector. The company carried on business as an earthmoving contractor. E, who held 9,400 shares, spent most of his time away from Christchurch while engaged in carrying out the objector's contracts. E arranged for mail to be delivered to his home in the city and to be forwarded to him on the job each week. After reading his mail he forwarded cheques and accounts to K for banking and payment. Initially cheques were countersigned by E, but due to his absence from the city for long periods he adopted the practice of signing cheques in blank and leaving K to complete and sign them as required to pay accounts. Unknown to E, K siphoned money from the company for five years and was found guilty of theft from the company. The objector had contended unsuccessfully that the loss incurred by these thefts was a loss deductible from his assessable income pursuant to s. 111 of the Land and Income Tax Act 1954.

Section 111(1) of the New Zealand Land and Income Tax Act, 1954, read as follows:

In calculating the assessable income of any person deriving assessable income from one source only, any expenditure or loss exclusively incurred in the production of the assessable income for any income year may, except as otherwise provided in this Act, be deducted from the total income derived for that year.

The Court allowed the loss occasioned by the theft to be deducted from income. Casey, J. found that K, a Mr. Kernahan:

. . . was in nothing like the position of the managing director in Curtis's case who could exercise an overriding control to take the money independently of the company's normal operations. Although a director, Mr. Kernahan was nothing more than the company's accountant so far as these defalcations were concerned. The money came into his control during the normal revenue receiving operations of the company, and he was expected to handle these funds in accordance with the policy decisions of Mr. Evans. In the course of doing so he stole them. On the facts of this case I cannot see how this could be regarded as a loss of capital (as the board held in Case 7); the evidence indicated that the monies coming into Mr. Kernahan's control were in the nature of normal trading receipts. I adopt the comment of the High Court of Australia in Charles Moore & Co (WA) Pty Ltd. v. Federal Commissioner of Taxation (1956) 95 CLR 344:

. . . we are here dealing with a loss incurred in an operation of business concerned with the regular inflow of revenue, not with the loss of or concerning part of the “profit yielding subject”. (ibid, 351)

When a taxpayer carries on a business he is exposed to all of the risks of that business. The risks include damage to property used in the business, liability for the torts or delicts of its employees in the course of their employment as well as theft, embezzlement or defalcation by employees while working for the employer in the course of business. To protect themselves against such exposure businesses may insure their properties against damage and bond their employees. Packer, for example, contracted with an insurer to bond Mr. Rochefort. Clearly, even before Mr. Rochefort's transgressions, Packer was aware of the potential for an employee such as Mr. Rochefort to steal. There is, in carrying on a business, an inherent risk that employees may steal. The use of employees in a business is necessary to carrying on that business. In hiring persons for employment an employer may hire dishonest people: that is a risk he takes in carrying on the business.

That Mr. Rochefort was a senior employee, if not the senior employee, of Packer is undeniable. As I have previously stated, the fact alone he was a senior employee is not in and by itself sufficient to disallow the losses due to his thefts.

Mr. Rochefort commenced defrauding Packer in 1978 when he was controller and before his appointment in October 1981, to vice-president and general manager of Packer. When he began his theft of funds he did not have "complete discretion” over the operations of Packer and was responsible to Mr. Faubert. Even after his appointment as general manager he was obliged to report monthly to, and follow rules determined by, his superiors. Packer's business was controlled by Mr. Rochefort's superiors. This is not a case like Curtis, op. cit., and General Stampings, op. cit., for example, where the person defrauding his employer was in sole control of the employer's business.

Mr. Rochefort drew cheques on Packer's account to defraud Packer in the Same manner as when he drew cheques required in the normal course of carrying on the business. The funds defalcated were not funds already earned by Packer; these funds were intended to be used by Packer in carrying on its business. The amounts defalcated were considered by Packer to be a cost of goods. As Casey, J. concluded in W.G. Evans, op. cit., at page 435:

The fact that be was also a director, shareholder and officer of the company does not alter the fact that he misappropriated the money while dealing with it as part of the company's activities, and not by the exercise of overriding power or control outside those activities altogether, as did the sole managing director in Curtis's case. The risk of such defalcations was inherent in the operations of the company carried on by necessity in this way, and accordingly the resulting loss is fairly incidental to the production of the assessable income and is deductible.

Mr. Rochefort did not defalcate money qua director or general manager of Packer; he had been stealing funds before his promotion to these offices. It is true, as respondent's counsel suggested, that Mr. Rochefort did not defalcate the funds qua employee since it is not in the exercise of his employment but on the occasion of and by virtue of his employment that any employee steals. Mr. Rochefort defalcated the funds qua thief: Poynton v. The Queen, [1972] C.T.C. 411; 72 D.T.C. 6329 at 420 (D.T.C. 6336). In Poynton the Ontario Court of Appeal held that amounts of money fraudulently obtained by a senior employee were benefits received or enjoyed by him in respect of, in the course of, or by virtue of his office or employment (pages 419-20 (D.T.C. 6335). Some thieves may become employees and it is a risk in operating a business that dishonest people may be employed. In the course of being employed in the carrying on of the business the thief may work in an area of the business that gives him access or opportunity to commit his misdeeds. This is what transpired in the appeal at bar. Mr. Rochefort's defalcations since 1978 resulted from the employment of Mr. Rochefort by Packer in the latter's business. The amounts lost due to the defalcations were non-capital losses, the deductions of which are deductible in computing profit in accordance with ordinary commercial principles and are not prohibited by the Act.

The appeals will be allowed with costs.

Appeals allowed.