Palardy v. R., [1997] 2 CTC 2906, [1997] DTC 1043

Teskey T.CJ.:

The Appellant appeals his assessment of income tax for the calendar years 1989, 1990, 1991 and 1992.

During the years in question, the Appellant was receiving weekly cheques from 443134 Ontario Limited, trading under the firm name of Peninsula Electric (the “Corporation”). These cheques were shown in the corporate books as wages to the Appellant throughout the entire four year period. Except for a 12-month period, these amounts were not reported as income by the Appellant and the assessments appealed from placed these amounts into income, except for a 12-month period where the financial statements show these amounts as return of capital to the Appellant on his shareholder loan.

Issues

1) The first issue is whether these amounts are income or return of capital;

2) There is only a second issue, if in calendar year 1989, these payments are income. If so determined, the second issue is whether the reassessment for the 1989 year is statute-barred or does the assessment fall within the provisions of subparagraph 152(4)(#)(i) of the Income Tax Act (the “Act”).

This whole provision reads:

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

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

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

Viva Voce evidence was given by Terry Roseanne Proulx (the “Bookkeeper”), Robert Andrew Nori (the “Chartered Accountant”) and Robert Palardy (the “Appellant”). Dealing with the testimony of each one individually, I make the following comments and finding of fact.

The Bookkeeper

The Bookkeeper was employed by the Corporation during the pertinent period. She was a neutral arm’s length witness, whose testimony was the most reliable.

She claimed that either the Chartered Accountant or the Appellant instructed her to pay the $800 a week that the Appellant started receiving on July 7, 1989, and show these payments on the Corporation’s records as wages. I accept this as a fact. The weekly payments of $800 to the Appellant continued from July 7, up to the end of February 1992 and thereafter, the payments were reduced to $500 a week. These weekly sums were shown as wages in both the General Ledger books and Payroll books of the Corporation.

The Bookkeeper characterised these weekly payments as a draw and was told that the Chartered Accountant would take care of everything at the year-end. I accept this as factual. No source deductions were ever made on these monies. She prepared the cheques and the Appellant signed the same.

She denies that she had any discussion with the Appellant that the $800 should be shown in the shareholder’s account. I accept this as fact. There was a lot of activity both in and out of the shareholder’s account.

During the calendar year 1991, the Payroll book shows the Appellant receiving $40,000 in wages. The General Ledger book also shows this same amount.

She also stated that she had no discussion with the Appellant concerning the shareholder’s account and that he never kept track of it. She was not concerned as she expected the Chartered Accountant would deal with these payments at year-end.

Sometime after April 30th, 1990, she prepared a summary of the shareholders account for the period October 1989 to April 1990 for the Chartered Accountant (Exhibit A-13), on which she wrote the following note:

Note! Bob began paying himself $800/week at the beginning of July/89

I did not make him a T4 as no deductions were remitted on his behalf

The Chartered Accountant

He became a qualified chartered accountant in 1977. He started doing the Corporation’s financial statements and income tax returns, as well as doing the Appellant’s personal tax returns around 1982.

The Chartered Accountant calculated the Appellant’s income, which he classified as business income, being the money the Appellant took out from time to time out of the shareholder’s account.

The financial statement of the Corporation, for the year ended April 30, 1990, on the page headed “Statement of Income (Loss)”, under the heading “Other Expenses”, shows management salaries and fees $80,000. The previous year, the figure was $90,000. These two figures were the total amount the Appellant took out of the shareholder’s account during the fiscal year of the Corporation.

In the Appellant’s T1 tax return for the calendar year 1989, under “Selfemployment” the amount of $90,000 appears on line 135. (This should have been shown at line 101).

Under “Self-employment income”, the $80,000 figure appears at line 135 of the Appellant’s T1 tax return for the calendar year 1990. (This again, should have been shown at Line 101.)

When the accountant was asked when and what he did to prepare the Appellant’s annual T1 tax return, he said the return would be prepared in April, after the year in question and that he would arrange for the Appellant to bring in any RRSP and charitable donation receipts, as well as any T4 or TSs he might have received. He then would look at the Corporation’s financial statement for the year-end April 30, the previous year, to see what the Appellant had drawn out of the Corporation during the Corporation’s fiscal year, and declare that as income, and in accordance, prepare his T1 tax return.

Thus, in April of 1990, when he was preparing the Appellant’s 1989 T1 tax return for income, he just looked at the Corporation’s financial statement for the year ended April 30, 1989.

When asked, if he looked at the Corporation’s records for the period May 1st, 1989 to December 31st, 1989, he took the ridiculous position that there was no need to.

This position is not acceptable. Money coming out of a corporation can only be:

(1) income to the recipient;

(2) a dividend duly declared;

(3) a loan duly documented;

(4) a withdrawal of capital duly documented.

The taxation year of the Appellant is the calendar year. There is no corporate records that show the Appellant was taking interest free loans from the shareholder’s account. He was just using this “Due to from shareholder" column as a way of recording money taken out of the company.

Thus, in order to do a proper T1 tax return for the Appellant, he should have had regard to the corporate records of the company, re: dividends, bonus, wages and all other monies paid to the Appellant during the calendar year in question.

He obviously had been treating the withdrawal from the shareholder’s account as independent interest free loans and then showing the amount as business income in the Corporation’s financial statement and using that figure for the Appellant’s personal T1 tax return. This of course was all done after the fact.

Thus, each of the T1 General tax returns of the Appellant herein do not reflect the proper income received in any of the calendar years before me.

I found the accountant not to be a reliable witness. His employees and himself made numerous errors.

Everyone in the accountant’s office either did not read the note on Exhibit A-13 or ignored it, as well as the General Ledger books which they had before them. The $800 is right there, and could be seen by anyone, giving the slightest perusal of these books. These weekly sums are all shown and all listed under “Wages”.

The obvious accumulated errors made by the accountant are: (he certainly could have made others)

(1) he failed to take into account, in any way, the weekly payments;

(2) he discovered these weekly draws when preparing the financial statements for the Corporation’s year ended April 30, 1992, (this was prior to the audit), he treated the $40,000 as a return of capital to the Appellant, but did not backtrack or made any enquiries concerning previous years;

(3) the next year, he ignored the draws again and made no enquiries, nor set up procedures so that these weekly sums would not be ignored; (4) he prepared all of the Appellant’s T1 tax returns on the basis of money received during a fiscal year of the Corporation and not on money received in the calendar year;

(5) notes on the Corporation’s financial statements for the year ended April 30, 1991 shows a long term debt to Goldcrest Holdings of $55,000 by the Corporation. Goldcrest Holdings did not loan the Corporation any money. The Appellant borrowed the money from Goldcrest Holdings and then made a shareholder loan to the Corporation;

(6) note 4 in the Corporation’s financial statement for the year ended April 30, 1992, shows a long term debt of $75,000 by the Corporation. This again should have been shown as a shareholder loan to the Corporation;

These last two errors were both items that one phone call to the Appellant could have cleared up, or by a simple check of corporate records. The Accountant did not seem to be overly concerned that the financial statements he was preparing were inaccurate.

If proper time had been spent in reviewing all statements and tax returns with the Appellant, all these errors should have been discovered. The Appellant knew that both loans were personal and that he, in turn, loaned the money to the Corporation.

The Appellant

The Appellant, an electrician, who is a hard working small businessman, and is the only director officer and shareholder of the Corporation, made no attempt to hide anything. All transactions were recorded and plainly visible.

Where his testimony conflicts with the Bookkeeper’s, I have accepted the Bookkeeper’s version of the facts as accurate. I believe part of the Appellant’s version is after the fact. He knew when his company was doing well and just drew out money when he needed or wanted it. He did not pay attention to the shareholder’s account.

I accept his statement that he told the accountant or discussed with the accountant that he was going to start taking $800 a week on July 7th, 1989.

The Appellant relied completely upon the accountant. He took no responsibility whatsoever in regards to the Corporation’s financial statements, of its corporate tax return nor his own T1 tax return.

Analysis

The Appellant in his Notice of Appeal, pleaded in paragraph 5 thereof: 5. When the Peninsula’s accountant was preparing the financial statements for Peninsula for the 1992 corporate tax year, he noticed the error in that year’s records and instructed Peninsula to amend the records to reflect the correct entry against the “Shareholder Loan” account for the 1992 corporate year.

When the accountant was asked if this was true, he first stated “yes”. Under cross-examination, he acknowledged that he instructed no one, but simply amended his working papers and prepared the financial statements to reflect this.

In spite of the fact that these after year-end entries were accepted by the Minister, I must quote my colleague Bowman, T.C.C.J., when he said, in Weisdorf v. R., [1993] 2 C.T.C. 2756 (T.C.C.) a decision dated August 27, 1993:

Accounting entries do not create reality. Their function is to reflect it. There seems to be an assumption that an accounting entry made after year end can retroactively determine the nature of events that purportedly occurred before the end of the year...

The accounting practice that went on herein is not acceptable. The Appellant’s taxation year is the calendar year. The Appellant and his accountant, in December of each year, ought to have looked at the money received by the Appellant from the Corporation during the calendar year, and if any corporate determination or documentation had to be made, then it would be made prior to December 31st, and not retrospectively.

A taxpayer must take responsibility for the returns. Even if a taxpayer is relying heavily on his or her tax return preparer, there is a duty to make enquiries, ask questions and review in detail all documents prepared by the tax return preparer.

The T1 general tax return has the following certification, which each individual who files a T1 tax return signs:

I hereby certify that the information given on this return and any document attached is true, correct and complete in every respect and fully discloses my income from all sources.

A corporate tax return has the following certificate:

I certify that this return, including accompanying schedules and statements, has been examined by me and is true, correct and complete return. I further certify that the method of computing income for this taxation year is consistent with that of the previous year, except as specifically disclosed in a statement of this return.

Linden, J.A., of the Federal Court of Appeal, in Friedberg v. R., (1991), 92 D.T.C. 6031 (Fed. C.A.), said at page 6032:

In tax law, form matters. A mere subjective intention, here as elsewhere in the tax field, is not by itself sufficient to alter the characterization of a transaction for tax purposes. If a taxpayer arranges his affairs in certain formal ways, enormous tax advantages can be obtained, even though the main reason for these arrangements may be to save tax (see The Queen v. Irving Oil 91 D.T.C. 5106, per Mahoney, J.A.). If a taxpayer fails to take the correct formal steps, however, tax may have to be paid. If this were not so, Revenue Canada and the courts would be engaged in endless exercises to determine the true intentions behind certain transactions. Taxpayers and the Crown would seek to restructure dealings after the fact so as to take advantage of the tax law or to make taxpayers pay tax that they might otherwise not have to pay. While evidence of intention may be used by the Courts on occasion to clarify dealings, it is rarely determinative. In sum, evidence of subjective intention cannot be used to “correct” documents which clearly point in a particular direction.

With this legal principle before me, I determine that these weekly sums received by the Appellant, from July 1st, 1989 up to April 30, 1991, was income. The Appellant’s appeals for 1990 and 1991 are therefore dismissed.

In regards to the issue whether the 1989 reassessment is statute-barred or not, I conclude it is not, on the authority of Nesbitt v. R., (1996), 96 D.T.C. 6588 (Fed. C.A.). Strayer, J.A., said therein, at page 6589:

...It appears to me that one purpose of subsection 152(4) is to promote careful and accurate completion of income tax returns. Whether or not there is misrepresentation through neglect or carelessness in the completion of a return is determinable at the time the return is filed. A misrepresentation has occurred if there is an incorrect statement on the return form, at least one that is material to the purposes of the return and to any future reassessment. It remains a misrepresentation even if the Minister could or does, by a careful analysis of the supporting material, perceive the error on the return form. It would undermine the selfreporting nature of the tax system if taxpayers could be careless in the completion of returns while providing accurate basic data in working papers, on the chance that the Minister would not find the error but, if he did within four years, the worst consequence would be a correct reassessment at that time.

Thus the appeal for the year 1989 is also dismissed.

I find that the appeal for 1992 falls into a different category. The Chartered Accountant designated the weekly sums received between May 1st, 1991 and April 30, 1992, (when they came to his attention) as payments on capital to the Appellant. This was accepted by the Minister of National Revenue in his subsequent audit of the Corporation.

This action by the Chartered Accountant and the subsequent tax returns by both the Corporation and the Appellant establishes that for that period, the payments were capital and repayments of the shareholder loan.

How the accountant failed to deal with these payments for the period of May 1st, 1992 to December 31, 1992, is inexplicable. However, there is no doubt that for this period, the Appellant thought he was receiving his own money back and if either the Appellant or his accountant had, for even one brief second, considered these sums, it would have been shown as a return on capital. The correction of the accountant would have taken place during the months of July and August of 1992. Why written instructions were not given to the Bookkeeper right then to set up procedures so that these weekly sums would not be missed, is just another example of his lackadaisical attitude towards his work.

The 1992 appeal is allowed and the assessment is referred back to the Minister for reconsideration and reassessment, on the basis that the sum of $17,800 received by the Appellant during the period of May 1st, 1992 to December 31, 1992 was not income, but a return of capital.

The Respondent being the predominant winner in these appeals, she is awarded costs on a party-and-party basis.

Appeal allowed in part.