Armand Geoffroy v. Minister of National Revenue, [1980] CTC 2153, 80 DTC 1139

Guy Tremblay [TRANSLATION]:—This case was heard at Sherbrooke, Quebec on January 24, 1979.

1. Point at Issue

The question is whether the appellant is correct in appealing from notices of reassessment issued by the respondent with respect to the 1974 and 1975 taxation years. The respondent included in calculation of the appellant’s net income for these two years the sums of $6,232 and $18,878.08. According to the respondent, these amounts were spent by Geoffroy Construction Inc for the benefit of the appellant, its principal shareholder. Furthermore, penalties of $287.17 and $1,191.32 were imposed for fraud or gross negligence.

2. Burden of Proof

The burden is on the appellant to show that the respondent’s assessments are incorrect. This burden of proof derives not from one particular section of the Income Tax Act, but from a number of judicial decisions, including the judgment delivered by the Supreme Court of Canada in P W S Johnston v MNP, [1948] CTC 195; 3 DTC 1182.

On the other hand, for the respondent to succeed in having the penalties upheld, he must show that the appellant committed gross negligence by improperly filing his own tax returns for the years in question. This burden derives from subsections 163(2) and (3) of the new Act.

3. Facts

3.01 The appellant is the principal shareholder and president of Geoffroy Construction Inc, incorporated in September 1970 and having commercial and residential construction as its principal purpose.

3.02 His daughter Lise has been a shareholder of the company since August 1973. She holds one ordinary share (Exhibit A-4), which she allegedly acquired from Clément Rouillard. However, the transfer of this share does not appear on the books of the company. Mr Lippe, a witness for the respondent, maintained that the shareholders registered in the books are the appellant (1,998 shares), his wife (one share) and Mr Clément Rouillard (one share). Mr Rouillard, who is an apprentice CA, testified that he had been a shareholder of the company from 1970 to 1973, and that in 1973 he transferred the only share owned by him to Lise Geoffroy.

3.03 In 1974, Lise Geoffroy was working for the company as its secretary. Between the fall of 1974 and the spring of 1975, the company built a house for Lise Geoffroy, who became Lise Geoffroy-Choquette in February 1974.

3.04 There was no written building contract between the company and Lise Geoffroy-Choquette. Rather, it was verbally agreed, according to the appellant, that invoices for materials used and labour employed during the construction would be collected, and the price subsequently set and reimbursement made.

3.05 During the construction, invoices for materials used for this purpose and labour employed were changed to “Job Choquette”.

3.06 Toward the end of the construction period, and for the purpose of enabling their daughter to purchase furniture, the appellant and his wife loaned her the sum of $10,000.

3.07 On November 27, 1975 a loan contract was concluded between Mrs Lise Geoffroy-Choquette on the one hand and her father and mother on the other, the latter being the lenders. This contract was filed as Exhibit A-3. The contract reads as follows:

On NOVEMBER 27, one thousand nine hundred and seventy-five;

BEFORE MR RAYMOND DROUIN, Notary, at Sherbrooke, province of Quebec, Canada;

APPEARED:

Dame LISE GEOFFROY-CHOQUETTE, secretary, residing at Cookshire, RR No 4, wife of Mr Charles CHOQUETTE, mechanic, of the same place, with whom she states that she has contracted her first marriage, under the regime of separation of property, in accordance with the terms of the contract of marriage concluded before Mr Raymond Drouin, notary, on January 9, one thousand nine hundred and seventy-four, registered at Sherbrooke as No 198170;

hereinafter referred to as “THE BORROWER”

AND:

Mr ARMAND GEOFFROY, builder, residing at 716 rue Chalifoux, Sherbrooke;

and

Dame LEONETTE DODIER-GEOFFROY, wife of the said Armand GEOFFROY, residing at 716 rue Chalifoux, Sherbrooke;

hereinafter referred to as “THE LENDERS”

WHO have agreed as follows:

LOAN

The borrower hereby states and acknowledges that she is indebted to the lenders in the amount of $35,000 for a loan made to her by the lenders, which she states that she has received to her complete satisfaction, and gives release therefor.

REPAYMENT

The borrower promises and undertakes for herself, her heirs and assigns to repay the said amount to the lenders in specie, at their residence or on their order, or to their heirs and beneficiaries at their residence, without notice being required, in equal consecutive monthly payments of $150 each, commencing on September 1, one thousand nine hundred and seventy-five.

Any balance still due shall become payable on September 1, one thousand nine hundred and eighty.

It is hereby agreed that the borrower may repay the said sum in whole or in part in advance at any time.

SPECIAL CONDITIONS

To guarantee repayment of the sum loaned, the borrower undertakes to comply with the following special conditions, which relate to a property located at Cookshire, RR No 4, on part of lot No THREE “D” (Part 3D), in range 1 (R 1), in the official plan and book of reference of the Township of Westbury, and owned by the borrower, Dame Lise Geoffroy-Choquette, under a deed registered at Cookshire as No 92836:

1. Subject to any balance remaining due hereunder becoming immediately payable, the borrower shall not sell or hypothecate the said immovable, in whole or in part;

2. The lender shall keep the said immovable in good repair;

3. The borrower shall pay as they become due all municipal and school taxes,

and other real estate charges that may be imposed on the said immovable;

4. The borrower shall carry fire insurance, to the satisfaction and to the benefit of the lenders, in an amount at all times covering the sum loaned, on the buildings built on the said immovable, and maintain such insurance until this loan is repaid in full; deliver the insurance policy to the lenders without delay; and provide them with the renewal certificate at least 5 days before expiry of the policy; and further deliver and immediately transfer to the lenders any related fire insurance policies.

In the event that the borrower fails to comply with this insurance clause, the lenders may themselves obtain insurance on the aforesaid buildings, at their option, and monies spent by them for this purpose shall be immediately due them by the borrower.

In the event of loss, the lenders reserve the option to apply the amount of the indemnity against a reduction of the claim, or to use it, in whole or in part, to rebuild or repair the said buildings, and their rights and privileges shall in no way be affected by the fact of receiving such monies.

EXPIRY OF TERM

In the event of failure by the borrower to make any of the payments stipulated above within 6 months of the due date, the lenders shall be entitled to require their loan to be immediately repaid.

DEATH OF BORROWER

In the event of the death of the borrower, Dame Lise Geoffroy-Choquette, before the said sum has been paid in full, the lenders agree to allow her beneficiaries and/or heirs to continue to repay the said sum by monthly, equal and consecutive payments of $150 each, provided however that they pay in addition annual interest at the rate then current.

FURTHER GUARANTEE

Until the said sum is repaid in full, the lenders may require the borrower, who hereby undertakes to comply with such a request, to make to them a good and valid first hypothec on the immovable described above, as a guarantee of repayment of the debt or of any balance remaining due thereon. Such a request for a hypothecary guarantee may be made at any time, and the cost of the notarized deed relating thereto shall be paid by the borrower.

This clause shall further be binding on the beneficiaries and/or heirs of the borrower.

DONE at Sherbrooke, as No FIVE THOUSAND FOUR HUNDRED AND SIXTYEIGHT (5,468) of the minutes of the undersigned notary.

Signed: Lise Geoffroy-Choquette

: Armand Geoffroy

: Léonette Dodier Geoffroy : Raymond Drouin, notary.

3.08 In his testimony the appellant, Mr Armand Geoffroy, stated that this amount of $35,000 was based, first, on $10,000 already loaned for furniture by himself and his wife, and $25,000 which was the cost of materials and labour paid by the company. He stated that he had borrowed the $25,000 from the company and reloaned it to his daughter. However, no document was filed on this loan from the company to the appellant.

3.09 The payment of $150 a month was made regularly to the lenders. However, no amount repaid to the lenders was repaid to the company, although in December 1978 the borrower repaid $2,500 directly to the company.

3.10 There is no indication of this use of funds in the financial statements of the company for 1974 and 1975.

Mr Jean Bélanger, CA, accountant and consultant to the company since 1970, testified that no audit was done in 1975 because of a temporary staff problem existing in the accounting firm, and that in 1974, despite the audit, the expense relating to “Job Choquette” was not established.

3.11 Mr Bélanger stated that he first heard of this expense in June 1976, when the 1975 financial statements had already been filed. He was told of it by the wife of the appellant. He was commissioned to examine the matter and regularize it, within the financial statements. He intended to treat the amount as an advance under subsection 15(2) of the new Act. The 1976 balance sheet (Exhibit A-7) does in fact contain under “Assets” the item “Advance to a shareholder”, $25,110. This $25,110 was taken from the Department of National Revenue information resulting from an investigation made by Mr Lippe in 1976, and represented inter alia the total for labour and materials.

3.12 In August 1976, Mr Bélanger went to the company’s office to perform his commission. He had been there two days when Mr Lippe, the respondent’s auditor, telephoned to tell him that he was going to conduct an investigation and asking him to put the books at his disposal. The appellant’s wife, who had taken the telephone call, gave the receiver to Mr Belanger. The latter told Mr Lippe that he was in the process of making an interim audit, but he would turn the matter over to him and continue later. In his testimony, Mr Lippe confirmed this telephone conversation with Mr Bélanger. However, it does not appear that Mr Bélanger explained to Mr Lippe the nature of his interim audit.

3.13 In his testimony, Mr Lippe stated that he found the men’s time sheets in the company’s office. The invoices for materials were found at Mrs Choquette’s house.

3.14 Mr Lippe maintained that at the time he was not told of the notarized contract, dated November 27, 1975, concluded between Mrs Choquette and her parents.

3.15 As a result of Mr Lippe’s investigation, the following paid expenses, incurred by the company in 1974 and 1975, were regarded as personal expenses of the appellant and included in his income as a benefit conferred on a shareholder:

In addition, penalties were imposed for the said years in the amounts of $287.17 (1974) and $1,191.32 (1975).

3.16 As a result of the notice of appeal and the agreements made at the hearing, only the amounts of $5,498 (1974) and $17,260.28 (1975) relating to the Rochette house were the subject of the appeal, as well as the penalties relating to those amounts. All of the other amounts in question are accordingly admitted by the appellant.

4. Act— Case Law—Comments

4.1 Act

The principal sections of the Act involved in the case at bar are subsections 15(1), 15(2), 56(2) and 163(2). They read as follows:

15.(1) Where in a taxation year

(a) a payment has been made by a corporation to a shareholder otherwise than pursuant to a bona fide business transaction,

(b) funds or property of a corporation have been appropriated in any manner whatever to, or for the benefit of, a shareholder, or

(c) a benefit or advantage has been conferred on a shareholder by a corporation,

otherwise than

(d) on the reduction of capital, the redemption of shares or the winding-up, discontinuance or reorganization of its business, or otherwise by way of a transaction to which section 84, 88 or Part II applies,

(e) by the payment of a dividend, or

(f) by conferring on all holders of common shares of the capital stock of the corporation a right to buy additional common shares thereof,

the amount or value thereof shall be included in computing the income of the shareholder for the year.

(2) Where a corporation has in a taxation year made a loan to a shareholder, the amount thereof shall be included in computing the income of the shareholder for the year unless

(a) the loan was made

(ii) to an officer or servant of the corporation to enable him or assist him to purchase or erect a dwelling house for his own occupation.

and bona fide arrangements were made at the time the loan was made for repayment thereof within a reasonable time.

56.2.(2) A payment or transfer of property made pursuant to the direction of, or with the concurrence of, a taxpayer to some other person for the benefit of the taxpayer or as a benefit that the taxpayer desired to have conferred on the other person shall be included in computing the taxpayer’s income to the extent that it would be if the payment or transfer had been made to him.

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, had made, or has participated in, assented to or acquiesced in the making of, a statement or omission in a return, certificate, statement or answer filed or made as required by or under this Act or a regulation, as a result of which the tax that would have been payable to him for a taxation year if the tax had been assessed on the basis of the information provided in the return, certificate, statement or answer is less than the tax payable by him for the year, is liable to a penalty of 25% of the amount by which the tax that would so have been payable is less than the tax payable by him for the year.

4.2 Case Law

The cases referred to by the parties are the following:

1. MNR v Allan Bronfman, [1965] CTC 378; 65 DTC 5235;

2. Charles Perrault v Her Majesty the Queen, [1976] CTC 65; 76 DTC 6021 ;

3. MNR v Louis Bisson, [1972] CTC 446; 72 DTC 6374;

4. Ryland H New v MNR, [1970] Tax ABC 700; 70 DTC 1415;

5. Mrs Lodie Saykaly v MNR, [1976] CTC 702; 76 DTC 6440;

6. Audrey Guthrie v MNR, [1972] CTC 2057; 72 DTC 1070;

7. Estate of Charles Alfred Pitt v MNR, 22 Tax ABC 57; 59 DTC 275;

8. Richard Reininger v MNR, 20 Tax ABC 242; 58 DTC 608;

9. Allan George Watts & Antoinette Cecile Watts v MNR, 27 Tax ABC 432; 61 DTC 592;

10. Ethel Annabelle Angle v MNR, [1969] CTC 624; 69 DTC 5423;

11. Her Majesty the Queen v Peter Neudorf, [1975] CTC 192; 75 DTC 5213;

12. Charles-Edouard St-Germain v MNR, [1969] CTC 194; 69 DTC 5086;

13. Michael Bruser v MNR, [1967] Tax ABC 45; 67 DTC 56;

14. James F Kennedy v MNR, [1972] CTC 429; 72 DTC 6357;

15. James F Kennedy v MNR, [1973] CTC 437; 73 DTC 5359;

16. Her Majesty the Queen v Frank Leslie, [1975] CTC 155; 75 DTC 5086;

17. George Willoughby Turner v MNR, [1969] Tax ABC 180; 69 DTC 168;

18. Estate of Thomas James Johnston v MNR, 35 Tax ABC 18; 64 DTC 204;

19. John Altenhof v MNR, [1973] CTC 2303; 73 DTC 239;

20. Chesley Arthur Crosbie v MNR, 23 Tax ABC 432; 60 DTC 147;

21. James Barber McLeod v MNR, [1928-34] CTC 88; 1 DTC 227.

4.3 Comments

4.3.1 Basis of Assessment

The respondent relied in making the assessment on subsection 56(2), cited above. It can be seen from looking at this section, first, that it is worded in very broad terms. Then, the application of this section is subject to the existence of three conditions.

4.3.1.1 First Condition

The first condition is that the payment or transfer of property was made “pursuant to the direction of’’ (in French: “suivant les instructions’’) and “with the concurrence of’’ (in French: “avec l’accord’’) the taxpayer. At first sight, the evidence to this effect seems clearly established. The appellant, the principal shareholder (1,998 shares, paragraph 3.02 of the facts) consented completely to the company building a house for his daughter, construction which was shown in the supporting documentation as “Job Choquette’’ (paragraph 3.02 of the facts).

4.3.1.2 Second Condition

The second condition is that the payment or transfer of property was made to another person “for the benefit of the taxpayer or as a benefit that the taxpayer desired to have conferred on the other person’’.

The evidence seems to be clear on this point: the appellant wanted his daughter to benefit from the resources of the company in building a house. 4.3.1.3 Third Condition

Finally, the third condition necessary for the section to be applicable is that the amount of the payment or transfer of property must be included in computing the taxpayer’s income “to the extent that it would be (in French: “dans la mesure où il le serait”) if the payment or transfer had been made to him”.

In the case at bar, if the transfer had been made to the appellant, that is to say, if the appellant had had a house built for himself using the services of the company and the same method as that used by Mrs Choquette and described in the evidence, would the appellant have been taxable? If the reply is yes, then an amount equivalent to the value of the property received by Mrs Choquette is taxable in the hands of the appellant. If the answer is no, it is not taxable.

4.3.2 The appellant and his accountant maintained that it is subparagraph 15(2)(a)(ii), cited above, which should be applied to Mrs Choquette. They argued that the latter, who is a shareholder and an employee of the company, was entitled to borrow from the company to have her house built or to have the company build her a house if she undertook to pay the price thereof within a reasonable time.

What is the evidence in this regard? The existence of a written contract between Mrs Choquette and the company was not established. If there was a verbal agreement, it was not proved for the years in question, namely 1974 and 1975. The written contract of November 1975, concluded between Mrs Choquette and her parents, and the regular monthly payments of $150 which she had made to them, showed that no contract existed between her and the company on the same subject, at least not in 1975,1976 and 1977. Is there something significant in the fact that after 1978 (that is, after investigation by the Department of National Revenue), and the making of assessments on the appellant, amounts were paid to the company by Mrs Choquette (paragraph 3.09 of the facts)? Did an agreement exist between Mrs Choquette and the company after 1978? No evidence was presented of this. Might there have been a new agreement between Mrs Choquette and her parents to terminate the written contract of November 1975? No evidence was presented in this regard. Were the regular payments of $150 a month to the parents merely repayment of the $10,000 (part of the loan paid for the furniture, paragraph 3.08 of the facts), and the payment of $2,500 in 1978 a commencement of repayment of the debt to the company? There is nothing in the evidence to show this.

Indeed, how is this payment of Mrs Choquette to the company to be explained, when the appellant stated in his testimony that it was he who borrowed the money from the company to lend to his daughter (paragraph 3.08 of the facts)? This agreement of a loan with the company by the appellant would seem to be purely verbal; but purely verbal with whom? The appellant is president and principal shareholder of the company. No minute of the company exists. There is not the slightest evidence in writing. In practice, the loan and repayment can only be a matter of intentions.

However, although it is true that in the world of business a significant number of agreements are made verbally, as the Federal Court of Appeal observed in Massey Ferguson Limited v The Queen, [1977] CTC 6; 77 DTC 5013, most of the time this situation creates no problems because the contracts are completed. The problem arises when it is necessary to present evidence of such a contract. In the case at bar, the only evidence presented is in practice evidence of intention: is this sufficient? The Board does not think so. Furthermore, according to subsection 15(2), the payments to the company have to be made within a “reasonable time’’, and no payment was made to the company in 1974, 1975, 1976 and 1977. Is this reasonable? The Board does not think so. Subsection 15(2) is an exempting section: it must be strictly interpreted.

In light of these considerations the Board concludes, first, that the third condition of subsection 15(2) has been met (see paragraph 4.3.1.3), namely that if the appellant had wanted to have the company build him a house, and had acted in the manner adopted by Mrs Choquette, the conditions of subparagraph 15(2)(a)(ii) would not have been met because of the absence of any evidence regarding the contract and the amounts would have been taxable in his hands.

The Board accordingly concludes that the respondent was correct in taxing the appellant on the basis of subsection 56(2).

4.3.3 Subsection 163(2) Penalty

Is the respondent justified in imposing a 25% penalty for failure to include in his income for the years 1974 and 1975 the amounts spent by the company for labour and materials used to build Mrs Choquette’s house? The question is whether the omission was made “knowingly, or under circumstances amounting to gross negligence”.

The burden of proof was on the respondent. It is very difficult to prove that the omission was deliberate, and such proof was not presented. The question therefore becomes whether fraud was involved. If the appellant intended to act fraudulently, he would not have kept his file marked “Job Choquette” with the majority of the documentation, which a simple audit could uncover: The appellant established in his testimony that he was intelligent, and if he had knowingly intended to defraud the tax authorities, he would not have committed such an egregious mistake as to provide evidence against himself on each expense relating to the house. Was negligence involved?

In the opinion of the Board negligence was involved, but what kind of negligence? Was it slight negligence, or so-called “gross” negligence?

A person may easily be guilty of slight negligence. The resulting forgetfulness is of the same kind.

The appellant undoubtedly had every intention of properly regularizing the “Job Choquette”. After the construction was complete in 1975, he entered into a contract which does not meet the conditions laid down by the Act for him to avoid taxation on the amounts spent by the company. On the one hand, appellant’s behaviour was exceedingly clumsy. He took the trouble to see a notary to have the problem resolved, and failed to resolve it properly. Did he have bad advice? There was no evidence to this effect. On the other hand, he did go to see someone who, in theory, should have been able to resolve his problem.

The Board strongly doubts that this was a case of negligence, and it chooses to resolve the doubt in the appellant’s favour. It allows the appeal regarding the penalty.

5. Conclusion

The appeal is allowed in part and the matter is referred back to the respondent for reconsideration and reassessment in accordance with the foregoing reasons for judgment.

Appeal allowed in part.