Fernand Larose v. Minister of National Revenue, [1981] CTC 2584, 81 DTC 198

D E Taylor:—This is related to an appeal against an income tax reassessment issued on September 29, 1979 for the year 1971. Many of the documents and much of the testimony at the hearing were in the French language but since the argument of counsel on the particular motion at issue was in English, this decision is written in that language. As always, an official translation is available from the Board.

Counsel for the Minister undertook at the hearing on December 2 and 3, 1980, to show that at least one item reassessed met the requirements under subsections 152(4) and (5) of the Income Tax Act, SC 1970-71-72, c 63, as amended, which deals with “statute-barred” years. Counsel for the appellant did not call evidence.

The hearing was adjourned so that the Board could consider a motion by counsel for the respondent that the obligation of the Minister had been met. Counsel made reference to the decision in Jet Metal Products Limited v MNR, [1979] CTC 2738; 79 DTC 624, (presently under appeal) in support of that motion.

The salient facts agreed upon are as follows:

— Appellant at all relevant times was a notary practising his profession in and around the City of Gatineau, Province of Quebec.

— Prior to 1971, appellant performed notarial services for Pointco Inc (“Pointco”) and in 1971, was owed fees by Pointco amounting to approximately $70,000.

— In 1969, appellant had contracted with Pointco for that company to construct a house for appellant on land purchased by appellant from Immeubles Gatineau Ltée.

— In 1970, the land on which Pointco was building homes was expropriated by the Government of the Province of Quebec.

— At no time during the construction of the house did appellant receive any statement of account from Pointco.

— During 1971, Pointco ceased its activities.

— The income tax reassessment was issued by the respondent after 4 years following the original assessment of tax for the appellant’s 1971 taxation year.

— Prior to 1969, appellant practised his notarial profession as a sole proprietor, employing two other notaries, Pierre Couture (“Couture”) and Gaétan Cousineau (“Cousineau”).

— In 1969, Couture became a partner in appellant’s practice being entitled to 15% of profits which calculation was to include most accounts receivable of the firm.

— In 1970, Cousineau also became a partner in appellant’s practice and it was agreed that profits including accounts receivable would be shared 65% for appellant, 20% for Couture and 15% for Cousineau.

— The arrangement referred to in above paragraph was never formalized by written instrument among the partners.

— The preparation of financial statements of the partnership, which were prepared on a cash basis, was the sole responsibility of appellant who would not have statements for a completed calendar year ready until just prior to the time when the individual partners had to file income tax returns for the completed calendar-fiscal year of the partnership.

— In his 1971 return of income, appellant reported one-third of the net income of the partnership for that year calculated on the cash basis.

— In the reassessment of tax for appellant’s 1971 taxation year, respondent added to appellant’s income:

(a) 60% of the 1971 net income of the partnership income calculated on the cash basis;

(b) an amount of $6,229.97 for accounts receivable before appellant’s partnership with Couture; and

(c) the amount of $40,000 for undeclared fees from Pointco.

From the total of the above, respondent deducted partneship income as reported by appellant.

The appellant contended that:

— Commencing in late 1969, Pointco ran into financial difficulties as the result of which appellant during 1969, 1970 and 1971 made payments to creditors of Pointco amounting to about $41,000, most of which pertained to the house appellant had asked Pointco to construct for him and the land on which such house was being constructed.

*(15) Upon reviewing the 1970 financial statements in early 1971, both Couture and Cousineau objected to the (existing financial arrangements) among the partners. It was finally agreed among the partners to report partnership income on a cash basis, one-third by each of the three partners, and in the event either Couture of Cousineau left the partnership, any of their unpaid receivables or shares therein would become the property of appellant.

*(18) Appellant and his two partners agreed to restructure their sharing of profits to include accounts receivable at the end of 1971 as they believed it was imperative for each of them to have accounts receivable at the start of tax reform in 1972.

*(19) An understanding was arrived at between the parties that they should have for income tax purposes reported income from the partnership for 1970 and 1971, such income to include accounts receivable at the end of those years, on a basis of an allocation of 60% to the appellant and 20% to each of Couture and Cousineau. Appellant undertook to reimburse Couture and Cousineau for any loss of income tax incurred by them resulting from the reporting of income on a cash basis.

— Respondent is statute-barred from issuing the reassessment in respect of the appellant’s 1971 taxation year by virtue of subsections 152(4) and

(5) of the Act.

— Alternatively, appellant in respect of his 1971 taxation year:

(a) did not have unreported fee income from Pointco of $40,000:

(b) properly reported income from his partnership with Couture and Cousineau; and

(c) should not be subject to a penalty under subsection 163(2) of the Act.

The respondent contended:

— In including the amount of $40,000 of undeclared fees in the appellant’s income for the 1971 taxation year, the Minister of National Revenue relied, inter alia, on the following facts:

(i) at all relevant times the appellant was a shareholder of Pointco Limited;

(ii) the appellant’s books of accounts showed that prior to 1971 Pointco Limited owed the appellant an amount of $70,797.20 for notarial services;

(iii) by an entry dated May 31, 1969 Pointco Limited debited its account payable to the appellant by $40,000 and credited the said amount to its account “long term debt”;

(iv) by an entry dated March 31, 1971 Pointco debited its accounts “long term debt” by an amount of $40,000 and credited the said amount of its account “sales”;

(v) in 1971 the appellant deleted an amount of $40,000 for his accounts receivable from Pointco Limited, leaving a balance of $30,797.20;

(vi) in 1969 the appellant had contracted with Pointco for that company to construct a house for the appellant;

(vii) while the appellant did make certain payments to creditors of Pointco pertaining to the house being constructed, he was later reimbursed for those amounts;

(viii) by reducing Pointco’s accounts receivable by $40,000 the appellant was in effect making a payment on account of the sale price of the house;

(ix) the said amount of $40,000 was not included by the appellant in the calculation of his income for tax purposes for the 1971 taxation year nor was it included for any other taxation year;

(x) the said amount of $40,000 was income from the appellant’s business.

— In addition to the above contentions (mainly points dealing with the “Pointco” matter), the Minister also made reference in the reply to the “partnership distribution” aspect of the assessment.

— He (the Minister) does not admit paragraphs 15, 18 and 19* of the statement of claim and puts the appellant to the strict proof thereof.

— The appellant’s share of the profits and of the accounts receivable from the business was 60%.

The evidence introduced by counsel for the respondent for the precise purpose of substantiating the Minister’s right to reassess dealt with both aspects of the assessment — “Pointco” and “Partnership distribution”. To minimize the necessity for giving details of documents and testimony, the Board has extracted those quotations from the argument of counsel for the respondent which appeared most relevant. Only the specific evidence connected with those specific arguments will be referenced. Counsel summarized his position in this way:

.. . the most obvious misrepresentation is the fact that the Appellant has filed his tax return as if he was only entitled to one-third of the profits of the partnership. Well, in my submission, we have established that he was entitled to sixty percent.

The other misrepresentation, of course, the other main representation in my Submission is that the Appellant has omitted to include in his income for 1971 an amount of $40,000, which as we have seen from all those entries seem to relate to the house that was built for him by Pointco Limited.

In my submission . . . this paragraph (19)t is an admission that the income for the 1970, 1971 taxation year is not properly reported and we have no evidence so far to establish why it was improperly reported. So that, in itself, in my respectful Submission, goes a long way to show that there was misrepresentation.

.. .I believe we have overwhelming evidence . . . that the actual profits of the partnership on a cash basis were split between the partners on th basis of sixty/ twenty/twenty and I can perhaps refer you to Exhibits 2 and 3. I believe we have introduced all . . . the back-up papers to show that all of the amounts were paid and only those amounts were paid and if we take Exhibit 2, we have for Pierre Couture the net amount of $62,987, which has been reconciled by Mr Cadieux, and we see the figure 20%, and then we have against that or subtracting, are the various withdrawals or payments made to them and we have a balance of $308 (another minor adjustment which was also explained), and then this amount of $235 is carried forward to the next year 1971 and to that amount is added the 20% of the net profits on a cash basis for 1971 and so on. I don’t believe I need to review all those documents in detail and refer to all the back-up papers, but in my respectful submission, they clearly establish that Mr Couture and Mr Cousineau were never entitled to or received one-third (1/3) of the profits of the partnership.

Mr Couture testified today and he mentioned that there was never, there was no agreement either written or oral to the effect that the sharing of the profits would be different and in this respect his evidence contradicts the statement made in paragraph 15* of the Notice of Appeal and if I can read from the second sentence, it is said:

*“lt was finally agreed among the partners to report partnership income on a cash basis, one-third by each of the three partners . ..”

In any event, (if) either Couture or Cousineau left the partnership unpaid or receivables would become part of the property of the Appellant.

Mr Couture testified there was never such an agreement and . . . in my submission, if there is to be an agreement between the partners, certainly the one partner should be aware of it.

*The paragraphs noted above (15, 18 and 19) for the statement of claim (the notice of appeal) have been reproduced above at in the contentions of the appellant.

fQuoted earlier in this decision under Contentions by the Appellant

.. . if I read this paragraph correctly [1] (“Paragraph 15 quoted earlier in the decision), the situation that is described in this paragraph is as follows. We have the two junior partners who are not satisfied because they were not getting enough money. There was a discussion and an agreement was made to report income on a one-third/one-third/one/third. How can this logically be said to solve the situation? Mr Couture and Mr Cousineau continued to receive 20% of the income as before. How can the fact that they reported on a one-third/one-third/one-third basis solve their problem? The only one who benefited from tnis arrangement, if an arrangement there was, was Mr Larose who saw his taxes for the 1970 and 1971 year reduced.

. . . It is clear we have at least a misrepresentation and the fact that this misrepresentation was made knowingly, it is clearly illustrated by Exhibit R-20 where the actual tax saving for Mr Larose, Mr Larose has calculated to the penny in R-20 and of course, R-20 is the sum of the figures which are found in other schedules. We have first of all Gaston and then we have his tax liability on the basis of one- third, which is defined in R-17 and on the basis of 15% which is found in R-16. The difference is the added cost for him of reporting on a one-third basis is $7,297.41. We have the same thing for Pierre Couture for whom the added cost is $6,192.96, for a total added cost of $13,490.37, and then we have the calculation of Mr Larose, Fernand Larose’s tax savings from the arrangement, which as calculated in R-8, in Schedule R-8, amounted to $16,791.46, for a net tax saving and we do have the net figure of $3,301.09.

Now . . . if the writer of this document did not know that he was doing, I’m afraid that I must submit that my case will fall.

. . . I can deal with the second aspect (the $40,000 “Pointco” amount), (and on it)

I will have very few remarks to make. We have a number of accounting remarks in the books of Pointco to show that the $40,000 was deleted and shown as a sale and then we have also an accounting entry in Mr Larose’s books deleting $40,000 from the accounts receivable of Pointco. Now, it would be a very strange coincidence . . . if Mr Larose had decided to just for some reason, I can’t give any reason, but he would have decided to reduce his accounts receivable by $40,000, the exact same amount that was deleted from the books of Pointco. Of course, I don’t need to mention I believe that Mr Larose had an interest in Pointco, a substantial interest all the way through a holding company. So, I think a reasonable assumption can be made that he knew what was going on, let alone the fact that the house was built in 1969, that he moved from the house in September 1969. What the letter from the Department seems to indicate, and my friend’s cross-examination seems to suggest, (is) that up until 1971 he had not been sent the bill. Well .. . when you have a house built for $40,000 and you don’t receive a bill and then, by coincidence, you find there is a matter of $40,000 deleted from your accounts receivable, I don’t have any explanation to say other than . . . that Mr Larose’s earnings were underestimated by $40,000. This was done knowingly, as evidenced by the entry in his books, and yet clearly there was a tax benefit to that effect since this amount was not included in his income. (Italics are mine)

Schedule 8 (referenced in a critical quotation above) is a sheet of paper on which several calculations were made allegedly in the handwriting of the appellant, showing that his income tax liability for the year 1970 would be $25,930.32 based upon a 65% share of the partnership income. Schedules 9 and 10, on identical paper and in similar handwriting, calculated the income tax payable for 1970 based upon a 1 / share of the partership income at $9,138.86. Schedules 12 and 13 are of the same nature, giving for Pierre Couture the amounts of $3,149,41 (at 20%) and $9,342.37 (at 1 For Gaétan Cousineau, the similar schedules are 16 and 17 showing calculations of $9,428.23 (at 15%) and $2,124.82 (at 14). These amounts were then transferred to Schedule 20 and, in the final analysis, a net total income tax saving of $3,301.09 indicated thereon. All the above documents were seized by Revenue Canada officials from the office files kept by Fernand Larose.

There was further evidence that all three partners filed their tax returns based on a / / / split of the partnership income. The accounting records and cancelled cheques presented, together with the testimony Pierre Couture, support the conclusion that the amount of income received by the appellant’s partners was based upon a 65-20-15% split of that income, not upon the alleged / / / arrangement. This evidence related to 1970 and was presented by the Minister to establish that a pattern for the calculated sharing and the reporting of income had been in existence before the year under review, and also to discredit any attempt to show that the apparent discrepancies might be related to “accounts receivable”. To do so it was necessary for the Minister to show that there had been, in fact, accounts receivable prior to the partnership. The evidence certainly leaves some questions unanswered, but I am satisfied, to paraphrase counsel’s words “the writer of this document (Schedule 8) . . . did .. . know what he was doing . .He was plainly calculating the net total income tax savings having regard to two different distribution percentage arrangements with his partners. I would see nothing wrong with that procedure providing the same distribution percentage used in the appellant’s income tax return was reflected in the actual receipt or allocation of income, not merely in a hypothetical calculation — which is the procedure alleged by the Minister.

The comment of Mr Couture in testimony that he is still requesting and awaiting (some 10 years later) a reconciliation and the receipt of any funds owing to him does little to support the appellant’s contentions that he (the appellant) only received or was entitled to the “one-third” of income reported in his tax return for 1970. Counsel for the appellant described the above-noted calculation as only a method of arriving at and determining relative “capital”, taking into account the accounts receivable. That is a pos- siblity, difficult to ascertain from the evidence and testimony, but nevertheless a possibility in view of the fact that there was no external professional accounting advice provided to the partnership during 1970. The fact is, however, that the Board is not required to make any decision for the year 1970 on the information relevant to it. The Board is satisfied that there were “accounts receivable” at the date of the formation of the partnership and that the evidence indicates these had been accumulated to the credit of the appellant as a sole proprietor. However, that does not eliminate the contention that for whatever reason the appellant may have chosen to allocate a portion of these accounts receivable to his incoming partners as their contributed capital. While the information related to 1970 does “set the scene” for dealing with the year under review, it does not establish the Minister’s case for the taxation year 1971.

With regard to 1971, the major exhibits upon which the Minister relied were consistent with the pattern of calculations demonstrated for 1970. The Minister concentrated to a substantial degree on documentation relevant to the tax return of Pierre Couture, and Mr Couture gave testimony himself on these documents. Schedules 21 and 22 were calculations of income tax for Pierre Couture for 1971 based on distribution of 20% and / respectively, and appeared to be prepared in the same way as the similar documents referenced earlier for the year 1970. He filed his income tax return for 1971 based upon a one-third share of the partnership income (Schedule 23). A critical portion of his testimony was that all matters of the administration had been left to Mr Larose, that he had merely signed his completed tax return when it was presented to him. There were additional calculations put in evidence, allegedly in the handwriting of the appellant, reconciling the respective income tax liabilities for Couture (based upon 20% and / sharing); and in the banking records of the partnership, the payment back to Couture for the difference could be traced. The total net income for the year 1971 reported at $87,781.70 could be traced back to the accounting records of the partnership, and that was the amount divided into thirds for income tax reporting. Several other sets of calculations also allegedly in the handwriting of the appellant dealt with the matter of accounts receivable — and how they were or should be apportioned to the partners. Mr Couture was not able to add much to the Board’s knowledge regarding the accounts receivable and how they were treated — if indeed they were taken into account at all. Officials from Revenue Canada charged with the audit and investigation provided the Board with testimony and calculations showing that one amount of $6,229.97 which consisted of accounts receivable before the partnership had been collected in 1971 and included in the earlier noted $87,781.70 net figure. It was the conclusion of Revenue Canada that the amount relative to the year 1971, which should have been divided among the partners no matter on what basis, was $81,551.73 ($87,781.70 — $6,229.97) and the reassessment of the appellant which is under review reflected this since that reassessment assigned 60% to Mr Larose rather than the one- third he had declared.

While this has been a complicated matter requiring considerable reconstruction and mathematics on the part of the Revenue Canada official, Mr Cadieux, the matter before the Board comes down to one thing — does the evidence support the contention of the appellant that during the year 1971 he was entitled to receive, and in fact received only one-third ( of the net income of the partnership; or was he entitled to receive a share greater than that and merely calculated the / proportion for purposes of reporting on his income tax return, which is alleged by the Minister? If the Board uses “receive” in the specific sense of “payment to’, then the evidence does not show such actual receipt. The fact is, however, that from an administrative point of view, Mr Larose did receive all of the gross revenue of the partnership, and thereby all of the net revenue. In his capacity as “senior partner”, “former sole proprietor”, “trustee” or in whatever manner his role should be designated, he was totally responsible for the administration of the affairs of the partnership — according to the evidence of Pierre Couture. There is no evidence that Pierre Couture could or did take for himself out of the business anything other than the amounts provided to him by Mr Larose and for the purposes determined by Mr Larose — “a weekly salary”, “share of profit”, or “restitution for additional income tax payments”. Pierre Couture’s assertion that is still waiting (10 years later) for reconciliation and payment from the partnership is not tenable. He left the partnership on May 5, 1972, the investigation into the affairs of Mr Larose commenced in 1975, and he agreed that nothing was paid in that interim period, or has been paid since, and he has done nothing about it. Based on his testimony that he is unaware of any agreement which would provide him with a one-third ( / share of the income, it is little wonder that the matter has not progressed.

There were some minor indications pointed out by counsel for the appellant in support of the contention that the “calculations” were designed to establish a capital base for the three partners by including accounts receivable. It was also noted that the “prior years’ accounts receivable” in the amount of $6,229.97 which were collected in 1971 were reported as income for 1971. However, another schedule (apparently in the handwriting of the appellant and bearing no 53) portrays alleged accounts receivable at certain dates — and at December 31/71 the breakdown between the partners of these “accounts receivable” is calculated on the basis of 60/20/20, not 1/3, 1 / 1 / which would be required to support the appellant’s assertion. As a point of interest, it is uncertain from the evidence that Pierre Couture ever received even this 20% allocation (which was portrayed at $24,340.95), let alone a one-third alloction, when he left the partnership a few months later. Two other schedules, numbers 21 and 22, also deal with accounts receivable, specifically the amount of $6,229.97 and eliminated it when the calculations to arrive at the 20% allocation of income for Pierre Couture were made. These factors leave in serious disarray the appellant’s assertion that the purpose of all the calculations was “to establish capital accounts and not to minimize income tax”.

In my view, counsel for the appellant summarized the appellant’s problem in argument as follows:

One final point is I did put a great deal of reliance on this date May 5, 72. However, all I said was that it was possible that a lot of those handwritten exhibits introduced by Mr. Cadieux were prepared after (that date). I did not say definitely, of course I could not say definitely, that they were prepared after because it is possible, I don’t know. There is no evidence from the author of those documents as to when exactly they were prepared.

The conclusion I reach on the balance of probabilities is that the Minister was entitled to recalculate the reported net income of the partnership for the 1971 ($87,781.70) so that one amount of $6,229.97 included therein should be credited to the income of the appellant, and so that of the balance ($81,551.73), an amount of $48,931.03 representing 60%, should also be credited to the appellant as income. The reassessment at issue for the year 1971 is therefore declared valid. The adjourned hearing will be rescheduled by the Board to provide the parties with an opportunity to bring forward further matters considered by them to be relevant to the appeal.