Antonio Magliaro v. Minister of National Revenue, [1980] CTC 2319, 80 DTC 1287

M J Bonner:—This is an appeal from an assessment of income tax for the appellant’s 1974 taxation year.

From 1972 to 1974 the appellant and another carried on business in partnership as bricklaying contractors. On May 1, 1974, the business and assets of the partnership were sold to a corporation in which the two were shareholders. As a result of the sale the corporation became indebted to the appellant in an amount exceeding $17,000. The appellant became an employee of the corporation. During 1974 the appellant received weekly payments from the corporation. It was common ground that the payments were made and received as salary. Income tax and pension instalments were withheld at source and duly remitted.

In February of 1975 the accountant who acted both for the appellant and the company approached the task of preparing the necessary T4 slips. He noted the appellant’s income for 1974 would be unusually high. He pointed that out at a meeting with the appellant and the other shareholder. He suggested that part of the amounts received as salary be redesignated as payments that were not income. The payments already made in 1974 were to be regarded as salary only to the extent of the instalments already remitted to the government. The remainder, so his suggestion went, should be treated as repayments on account of the debt owing by the corporation to the appellant as the result of the sale of the business. The appellant agreed to proceed on the suggested basis. The accountant prepared the appellant’s 1974 T4 slips and return of income on the basis of the proposal.

The recharacterization required the making of entries in the books of the company in order to reduce the salary expense recorded previously for the period between May, 1974, and the year end. This, the accountant testified, he made a mental note to do. However, he forgot to change the corporate records. In consequence, given the theory that the payments were to be redesignated as on account of the indebtedness, the corporate income was understated. The understatement remained undetected for several years until the corporate books were examined by the respondent in connection with an investigation of the financial affairs of the appellant’s partner.

By the assessment in question the respondent included in income the sum of $9,741.89, being the difference between salary paid to the appellant by the corporation and the salary declared. As well he imposed a penalty under subsection 163(2) of the Income Tax Act. Both the inclusion and the penalty are in issue in this appeal.

The appellant gave evidence. He was born in Italy. He received a limited education. He worked as a bricklayer there. In 1963 he emigrated to Canada, where again he worked as a bricklayer. He started the business in 1972. The appellant was, I concluded, an entirely candid witness but, and I say this with no disrespect, he was plainly unsophisticated, particularly in matters of tax and bookkeeping. Clearly, he had a limited grasp of financial matters. He stated that he trusted his accountant because many other businessmen went to him. The appellant pointed out that had he not been able to rely on that accountant he would have had to rely on another. He regarded himself as being incapable of preparing his own tax return.

In argument the appellant’s counsel correctly observed that had he looked at the situation from a planning point of view at the outset he could readily have set the payments up as repayments of the debt. He submitted that the Board should retroactively sanction the recharacterization as a plan which could have and should have been put into effect. He suggested that no great harm would be done to the tax system. Not surprisingly, he was not able to point to any authority supporting the submission. Liability for tax turns on the application to a factual situation of the provisions of the Income Tax Act. As noted previously, the payments in question were made and received as salary. That is the fact on which liability for taxation must turn. The argument flies in the face of the obvious; a fact cannot change, no matter how much the persons concerned wish that it were otherwise. Thus, the sum of $9,741.89, being the total of the payments in question, was properly included in the appellant’s income as salary.

In my view, however, the penalty was not properly imposed. The omission in the appellant’s return of the recharacterized salary resulted from his reliance on very bad advice given to him by his accountant. The appellant did not omit any amount which he knew could properly be regarded as income or which he was grossly negligent in regarding as not being income. The respondent’s counsel suggested that, having regard to the state of the corporate books, the requisite level of knowledge or negligence existed. The penalty was imposed in respect of the omission in the return of income of the appellant and not what would have been an overstatement of salary expense in the corporate accounts had the recharacterization been proper. Furthermore, it was not shown that at the time the appellant made his 1974 return he had any reason to doubt the competence of the accountant or to expect that the accounts of the company would not be “rectified”.

The appeal is therefore allowed and the assessment referred back to the respondent for reconsideration and reassessment on the basis that the appellant is not liable to the penalty imposed.

Appeal allowed.