Cheta v. R., [1998] 3 CTC 2298, 98 DTC 1805

O’Connor T.C.J.:

These appeals were heard on common evidence at Prince George, British Columbia, on November 3 and 4, 1997 pursuant to the General Procedure of this Court. After the hearing and as agreed, counsel for both parties submitted lengthy written submissions, the last of which was filed December 22, 1997.

Testimony for the Appellants was given by Yogendra Cheta (“Cheta”) and by Dean Mason, Chartered Accountant. For the Respondent (“Minister”) testimony was given by Brian Ellis, the auditor on the matter raised in these appeals and by Gary Bonderud, the appeals officer. Numerous exhibits were filed.

Although the pleadings refer to numerous issues, only four remained outstanding when the appeals were heard, namely: whether the Minister was correct (1) in including in the income of Minit-Tune (Prince George) Ltd. (the “corporation”) for its fiscal year ended February 28, 1990 alleged unreported sales of seven vehicles at a total price of $30,130; (2) in including in the corporation’s income for the said fiscal year unreported sales of vehicles at a total price of $29,994; (3) in including in the income of Cheta for the calendar year 1989 an amount of $30,130 as an alleged shareholder appropriation; and (4) in including in Cheta’s income for the calendar year 1990 an alleged shareholder appropriation of $18,894.

The most relevant assumptions contained in the Minister’s Reply to the corporation’s appeal read as follows:

a) in 1979, Minit-tune (Prince George) Ltd. (“Minit-tune”) commenced business as a franchise for automotive tune-up work;

b) in 1989, Minit-tune began to sell new and used cars, but also continued its business as a service centre;

c) at all material times since 1989, Yogendra Cheta (“Cheta”) was the sole shareholder and manager of Minit-tune and was also an employee of Minit-tune;

d) there were no set accounting procedures used by Minit-tune and no proper books of account were kept;

e) Minit-tune’s financial statements were prepared solely from financial information for the corporate accounts provided by its bank;

f) in October 1989, an adjusting journal entry was made in Minit-tune’s records to record cash sales of used vehicles by Cheta which were not deposited by Minit-tune to its account;

g) the entry debited shareholder’s loans for $30,130.00 and credited care sales for the same amount, but was not recorded in the financial statements;

h) in its fiscal year ending February 28, 1990, Minit-tune incorrectly included $18,894.00 in inventory for two vehicles it had returned to the former dealer;

1) Minit-tune did not receive the rebate for the two vehicles, but Cheta received the rebate in his capacity as shareholder and manager of Minit- tune;

j) the two vehicles are insufficiently accounted for in the records of Minit- tune and the recovered costs are not entered in the records of Minit- tune;

k) the amount of $18,894.00 was an appropriation by Cheta within the meaning of the Act;

The Reply to Cheta’s appeal also refers to the $30,130 (paragraph g) above) as an appropriation by Cheta in 1989.

Facts

Originally the records and books of the corporation were unsatisfactory. The corporation’s T2 return for the period ended February 28, 1990 were based on financial statements prepared by a Mr. Mintenko (Tab B-1 of Respondent’s Book of Documents (“R-B”)). Mr. Ellis, for the Minister, found that these financial statements could not be verified. At an early stage in the audit Mr. Ellis recommended that Cheta retain a chartered accountant to reconstruct the financial statements. Cheta retained Dean Mason who prepared new financial statements (R-B-4). These were prepared on the basis of agreements of sale (deal sheets) and reconciling these with the entries on the Social Service tax returns to the Province of British Columbia (in effect, sales tax returns) and with entries in the corporation’s bank account. These revised financial statements were filed with Revenue Canada and were accepted as the starting point of the audit.

The principal, if not the only, reason for the Minister’s position on the issue concerning the $30,130 was a one-page sheet of paper (third page of R-B-6) addressed to no one and prepared by an unknown person but presumably one of the corporation’s bookkeepers since the paper was found in the documents submitted by Cheta at the time of the audit. This paper indicates as “car sales not recorded” an amount of $30,130 and states that these should be recorded as an entry adjustment for October, 1989 showing car sales of $30,130 and a corresponding debit to “shareholder’s loan” of $30,130. This paper and other factors led the Minister to conclude that the corporation’s income should have been increased by $30,130 and that Cheta appropriated the said amount.

This paper also contained details of the price of each of seven vehicles, which prices totalled $30,130. Mason reviewed several of the exhibits matching the sales prices of each of seven vehicles with recorded sales and concluded that these sales were indeed recorded and included in the reported income of the corporation for the fiscal year ended February 28, 1990.1 found Mason’s evidence credible and convincing and I accept same. I conclude therefore that the Minister was not correct in adding $30,130 to the corporation’s income. Further, since the sales were included as income of the corporation and since there is no evidence that the $30,130 or an equivalent benefit went to Cheta, the said amount should not have been included in Cheta’s income for the calendar year 1989.

As to the alleged unreported sales totalling $29,994, the Minister first established the unreported sales at a much higher amount, namely $102,009. On receiving further documentation, the Minister acknowledged that $72,015 had been reported, thus reducing the original amount of $102,009 to $29,994 (R-B-12).

On this issue, Mason referred to Exhibit 3 of R-B-11 and established that the $29,994 represented the total sales prices of eight vehicles. He was able to establish that four of these vehicles were identifiable with four entries on his sales/inventory analysis (Exhibit 2 of R-B-ll) and concluded that the prices for those four had indeed been included and reported as income of the corporation. For the remaining four vehicles, Mason referred to the Appellant’s Book of Documents (“A-B”), Tabs B-4 to B-7 being four sales agreements. Three of these agreements (B-5, B-6 and B-7) were executed prior to March 1, 1989 and, therefore, according to the Appellants the prices of these were not to be included as income in the corporation’s fiscal period ended February 28, 1990. The remaining sales agreement (B-4) and attached credit data are undated. Mason however concluded from other documentation that the sales agreement was executed in February of 1989 and no contradictory evidence has been submitted. I have concluded therefore the sales agreements for four of the eight vehicles occurred in the 1989 fiscal period and not to be included in the corporation’s income for fiscal 1990. For the remaining four vehicles, the testimony is complicated, involving exchanges of vehicles with other car dealers (washouts) dates when revenue should have been recognized and other operations of a car dealership and sketchy written evidence. Mr. Mistry, who initiated the Minister’s inquiry on missing car sales, was not present to contradict Mason’s testimony which testimony I accept. That testimony established that the revenues from these remaining four sales was included in the Corporation’s income for fiscal 1990. Therefore, it follows that the Minister was incorrect in adding $29,994 to the corporation’s income in the fiscal period ended February 28, 1990.

The remaining issue is the alleged appropriation by Cheta of $18,894 in calendar 1990. The background to this issue can be summarized by quoting from the written argument of the Appellants as follows:

8. In or about October, 1989, Minit-Tune entered into an agreement with Hyundai Canada for the right to sell new and used Hyundai vehicles in the City of Prince George.

Mr. Cheta gave evidence at the hearing that Minit-Tune was encouraged by Hyundai Canada to purchase all parts from them. It was also Mr. Cheta’s evidence that he was reluctant to do this because Minit-Tune had previously entered into a ‘gentleman’s agreement’ for the purchase of parts from the proprietor of Pine Centre Hyundai, Mr. Al Fleury.

9. The Appellant Mini-Tune entered into a further agreement with Pine Centre Hyundai for the purchase of parts in or about October 1989. The terms of this Sale/Purchase Agreement (hereafter ‘the Parts Agreement’) are set out in correspondence dated April 25, 1990, from Mr. Doug Revell, Manager of Minit-Tune, to Mr. Al Fleury, Proprietor of Pine Centre Hyundai, located at Tab Al of the Appellants Book of Documents.

10. The Parts Agreement is essentially set out in the second paragraph of Mr. Revell’s letter where he writes:

...AS we understood during our meeting, Prince George Hyundai’s absolute final offer with respect to the purchase of Pine Centre Hyundai’s parts inventory is as documented:

$30,000 This includes parts, accessories and

special service tools delivered to Prince George Hyundai as well as Pine Centre Hyundai’s Brand Sign and Pine Centre Hyundai’s service repair order customer records.

11. While this is the only record of the Parts Agreement available to the Court, the evidence of Mr. Cheta was that the letter from Mr. Revell accurately set out the ‘gentleman’s agreement’ he entered into with Mr. Fleury of Pine Centre Hyundai.

It was also Mr. Cheta’s evidence that the Parts Agreement with Mr. Fleury was made in or about October, 1989, at about the time that Minit-Tune assumed the right to sell Hyundai vehicles from Hyundai Canada.

12. Financing for the Parts Agreement is set out on page two of Mr. Revell’s letter, where he writes:

... The financial arrangements will be completed as detailed:

You Owe We Owe

Us You

1. Pine Centre Inventory Parts,

accessories and special service

tools

$30,000.00

2. Outstanding Payables Pass-

port/Pine Centre

$ 1,353.28

3. Hyundai vehicles on consign-

ment

You Owe We Owe

Us You

a) VINLF 31-526053

$8,181.22

b) VINLD 21-255725

As per the accounting provided, we owe Pine Centre Hyundai $477.58. Final documentation and supporting documents will be provided...

13. At the hearing Mr. Cheta gave evidence that the arrangement with Mr. Fleury was carried out as set out in the letter of Mr. Revell. In other words Minit-Tune purchased $30,000.00 worth of parts from Pine Centre Hyundai. These parts were paid for by Minit-Tune with 3 payments of $10,838.71, 42,513.89, and $477.58 to Mr. Fleury. In addition, Mr. Fleury kept 2 vehicles as set out in item number 3 of Mr. Revell’s detail of financial arrangements. The bank loans outstanding on these vehicles were paid for by Minit-Tune.

14. Mr. Dean Mason gave evidence that the payments of $10,838.71, $2,513.89 and $477.58 were properly recorded in the financial records of Minit-Tune prepared by his office.

15. Mr. Mason and Mr. Cheta both gave evidence at the haring that the two vehicles referred to in the letter of Mr. Revell were never a part of the vehicle inventory of Minit-Tune, however, they were incorrectly included in the vehicle inventory and noted at that time to be valued as follows:

$9,848.00

$9,046.00

$18,894.00.

16. When asked why the sum of $18,894.00 was different than the sum of $17,115.52 noted in Mr. Revell’s letter, Mr. Mason gave evidence that because reference to the vehicles dealt with such exact numbers and Mr. Revell’s letter referred to the amount “as of April 16, 1990”, the sum of $17,115.52 likely reflected the amount outstanding on the flooring loan against the vehicles in question. That is to say Mr. Fleury took possession of the two vehicles in question and Minit-Tune paid for the remaining flooring loan owing against the vehicles.

Mr. Mason also gave evidence that valuations noted on the vehicle inventory were often different than the sale price or flooring loan outstanding for any one particular vehicle.

17. When asked to explain what a ‘flooring loan’ was Mr. Mason gave evidence that dealerships like the appellant Minit-Tune entered into financial arrangements with a bank for the purchase of new vehicles. These arrangements are referred to as ‘flooring loans’. In effect the Bank would loan the dealership funds to purchase new vehicles from Hyundai Canada, and it would be repaid to the Bank from the proceeds of the sale of the new vehicle by the dealership.

The testimony given substantially reflects the foregoing submissions and I accept that testimony to the extent that the two vehicles having a value of $18,894 were transferred to Hyundai Canada in partial payment of the total parts payment price of $30,000. I am further satisfied that the corporation, by reason of the foregoing, should be considered as having sold (or exchanged for parts) those vehicles with the result that the amount of $18,894 should have been included in the corporation’s gross income. In other words, I have seen nothing in the evidence that would support the Minister’s conclusion that the $18,894 was an amount appropriated in favour of Cheta. Consequently the said amount should not have been included as a shareholder appropriation to Cheta in 1990.

As mentioned above, the original appeals and the Replies thereto addressed many other issues in addition to the four discussed herein but those were resolved prior to the hearing. In conclusion, the appeals are allowed and the matters are referred back to the Minister for reconsideration and reassessment on the basis that

1. there shall be excluded from the 1990 income of the corporation the sums of $30,130 and $29,994; and

2. there shall be excluded from the income of Cheta the sums of $30,130 in 1989 and $18,894 in 1990.

Counsel for both parties in their written submissions, seek costs no matter what the outcome of the appeals. I have concluded that since these appeals probably would not have been necessary or not have taken so long if the Appellants’ records had been in order and since, as set out in Respondent’s submission, counsel for the Appellants was dilatory in many respects leading up to the hearing, no costs are awarded to the Appellant. However, I do not believe there are sufficient grounds for an award of costs to the Respondent. Consequently, there shall be no award of costs.

Appeal allowed.