Fukushima v. R., [1999] 2 CTC 2312, 99 DTC 553

Sarchuk T.C.J.:

These are appeals of S. Gordon Fukushima and Peter F. Strawson (the Appellants) from assessments of tax with respect to their 1987, 1988, 1989 and 1990 taxation years. By agreement of all parties, the appeals were heard together on common evidence. The facts giving rise to the assessments are not materially in dispute and can be summarized as follows:

(a) The Appellants were partners in Strawson, Fukushima, Enstrom, Chartered Accountants, carrying on business in Thunder Bay, Ontario. I [1] The partnership year end for each of the years in question was January 4.

(b) The partnership completed its income statements for each of the 1983 to 1993 fiscal periods on a full accrual basis, [2] that is the amounts in the income statements included work in progress (WIP) that had not been billed and therefore was not receivable by the partnership at the year end.

(c) In computing their incomes for their respective 1983 to 1993 taxation years, the Appellants elected not to include their respective portion of the partnership’s WIP at the year end pursuant to the provisions of section 34 of the Income Tax Act (the Act).

(d) Throughout this period of time, the Appellants failed to reverse the previous year’s deduction of WIP in their calculation of the taxable income of the following year. In result, they reported reduced taxable incomes for the 1987 through 1990 taxation years as follows: [3]

Year	Fukushima	Strawson
1987	$55,158	$54,599
1988	$52,510	$52,619
1989	$60,877	$61,444
1990	$89,640	$93,961

(e) The Appellants’ returns were initially assessed by the Minister on the

following dates:
Year	Fukushima	Strawson
1987	July 18, 1988	July 18, 1988
1988	May 24, 1989	May 24, 1989
1989	July 18, 1990	July 5, 1990
1990	July 29, 199]	June 26, 199]

(f) On June 17, 1994, the Appellants notified the Assistant Director, Audit Division, of the Thunder Bay District Office of Revenue Canada, that they had been underreporting their incomes for several years by not adding back the amount deducted pursuant to section 34 of the Act to their income in the taxation year following the year in which it was deducted.

(g) The Minister reassessed both Appellants for the years in issue on Febru

ary 2, 1995 and increased the income of each as follows:
Year	Fukushima	Strawson
1987	$ 8.151	$ 8,151
1988	$ 7,706	$ 7,706
1989	$13,576	$13,576
1990	$31,786	$31,786

The Minister also assessed, for the same reasons, the Appellants’ 1991, 1992 and 1993 taxation years. The Appellants did not appeal these reassessments as they were not statute-barred.

The quantum of the reassessments is not in dispute in these appeals and the sole issue is whether the Minister of National Revenue (the Minister) is entitled to reassess the taxation years in issue beyond the normal reassessment periods. To do so, the specific provisions of subparagraph 152(4)(rz)(i) of the Act require the Minister to demonstrate that the Appellants made misrepresentations attributable to neglect, carelessness or wilful default or committed any fraud in filing their respective returns or in supplying information under the Act. To this end, testimony was adduced by the Respondent from Strawson and from John R. Drew (Drew), an auditor with Revenue Canada.

Strawson received his designation as a Chartered Accountant in 1958. He worked for Revenue Canada as an assessor for 18 months and then spent the next 12 years with an accounting firm, Crawford, Reedhead & Company. Its business included performing the audits for the City of Fort William as well as for other municipalities in the surrounding area, several school boards, the hydro, etc. Stawson’s practice included audits for a number of hospitals and this led to his employment as the Director of Finance for the McKellar Hospital from 1972 to 1979. Then, following a brief association with a real estate company, he commenced his own accounting practice. In 1981 Strawson received an offer from the Lakehead University to replace a lecturer in introductory accounting for a period of one year. He approached Fukushima with whom he had worked on two previous occasions, and in the autumn of that year, they entered into a partnership. Because of their prior association with public sector work, the Appellants were known in that area with the result that their clientele included a municipality, several hospitals, a number of Aboriginal organizations in addition to their commercial clients. Strawson described the latter as “mom and pop companies” — generally small businesses in the three to four shareholder range. The nature of the tax work performed for them included the filing of corporate returns as well as individual personal tax returns. Strawson said he would not categorize himself or his partners as tax experts and if a complicated tax issue arose it was, as a general rule, referred to a tax specialist, preferably one with a national firm.

At all relevant times, Strawson was in charge of the office administration and had carriage of and responsibility for the preparation of the partnership’s financial statements. He testified that when he began his own practice the WIP was not accounted for in his financial statements. Upon joining the partnership, Fukushima suggested that some changes be made particularly in terms of recording. Strawson recalled that generally “he wanted to smarten things up” and specifically observed that WIP must be accounted for. As a result, they agreed to use the full accrual method in calculating their income for financial statement purposes. In order to determine how to go about reporting for income tax purposes, Strawson says he made reference to the Act and to an Information Bulletin discussing section

34. He noted that pursuant to that section: “We were permitted to deduct work in progress. I didn’t see anything about adding it back. So I thought, well, this seems a little strange. There’s something the matter here.” Although that raised questions which troubled him, he says his thought process was that “section 34 tells you to exclude from your income the work in progress at the end of the year. That’s apparently all it directs you to do,” but it does not say it is to be added back the following year or at any time. He further says that he was concerned enough to make reference to the file of a fairly large commercial client, B & J Equipment Rentals Limited, which had significant work in progress and concluded that its income was being properly recorded and picked up in the subsequent year. Based on the foregoing, the Appellants treated their WIP and computed their income for tax purposes in this manner, and continued to do so up to including their 1994 taxation year.

Mr. Drew has been with Revenue Canada for 23 years and is currently an auditor. He has both a business administration diploma and a Bachelor of Commerce degree (Honours). Following receipt of the Appellants’ voluntary disclosure, Drew reviewed the relevant material and recommended that the Minister reassess the Appellants pursuant to the provisions of subsection 152(4) of the Act. In his review of the Appellants’ returns and other material, Drew discovered that in the first taxation year in issue, the Appellants used the wrong form, namely a T2130, [4] which was not designed or intended for use by professionals in preparing their tax returns. In taxation years 1988 to 1990, they did use the correct form, a T2032. [5] He concluded that the Appellants’ difficulty commenced when they failed to transfer the information correctly from the partnerships’ financial statements and then compounded the error by using the wrong form in 1987. It was his experience that it is an accepted practice by accountants that the amount must be added back in the year following. This was the first time he had ever seen such an error made and was surprised that the Appellants, being accountants, had made it.

Respondent’s Position

The Respondent takes the position that the Appellants made misrepresentations of their taxable income in all of the years in question by failing to properly record and report their professional incomes, a fact not disputed by the Appellants. Furthermore, the Respondent contends that the evidence adduced supports the Minister’s assumption that these misrepresentations were the result of carelessness or negligence. Counsel for the Respondent submitted that both Appellants were involved in the maintenance of their records, the preparation of their respective returns, had sufficient knowledge of these records, and their relationship to their respective returns that each should have been aware of the errors made in the preparation of the returns. Counsel submitted that the misrepresentations were substantial in relation to each Appellant’s reported income. He referred, by way of example, to the fact that in 1987 the reported income was $54,000 which was increased on assessment by the amount of $8,151 and that in 1990, the amount of income reported was $93,961 which was increased for each of the Appellants by an amount of $31,786. These discrepancies were significant enough to put the Appellants on notice that errors were being made.

It was also submitted that the evidence has established that the Appellants were uncertain as to the correct utilization of the relevant provisions of the Act, yet failed to make any genuine inquiry into the proper way in which to report their WIP for income tax purposes. This, Counsel argued, demonstrates that reasonable care was not taken by the Appellants and is evidence of carelessness and negligence for the purposes of the relevant provisions of the Act.

Appellants’ Position

The Appellants contend that the Minister was barred from making the reassessments in issue because they were made beyond the period of time specified in subsection 152(4) of the Act. Their position is that the Minister is entitled to reassess beyond the normal reassessment period only if it can be established that the taxpayers made a misrepresentation that was attributable to negligence, carelessness or wilful default or committed a fraud in filing their respective income tax returns. Although the Appellants admit that the method used to compute their income in the taxation years in issue was wrong and that this error constituted a misrepresentation for the purpose of subparagraph 152(4)(fl)(i) of the Act, they contend that the Respondent has failed to establish that these misrepresentations were attributable to the Appellants’ neglect, carelessness or wilful default.

The primary thrust of the Appellants’ position is that Strawson was careful and diligent in the preparation of the partnership’s financial statements and in accounting for the WIP for income tax purposes. He acknowledged the issue, thought through the problem and arrived at a solution. In circumstances where a taxpayer turns his mind to the problem and duly considers the solution, as Strawson did, there can be no misrepresentation of the type described in subparagraph 152(4)(a)(1) of the Act simply because the solution is wrong. [6]

The Appellants say that in preparing their respective personal income tax returns, they exercised a standard of care that was above that of negligence or carelessness. Counsel submitted that the authorities cited have a common theme, i.e. that before a finding of negligence or carelessness can be made, there must be proof of “inattention, indifference, lack of concern or lack of reasonable care”. [7] In this case, these hallmarks of negligence and carelessness are absent. The Appellants made an honest effort to properly compute and report their taxable income for the years in question and there is no evidence to the contrary. On the other hand, the Respondent’s allegation that the Appellants were inattentive, indifferent or lacked concern is not supported by the facts.

Conclusion

To permit the Minister to rely on the provisions of subparagraph 152(4)(«)(i) of the Act, it is necessary for him to establish, not only that the Appellants committed an error in completing their tax returns but as well that the error was the result of negligence or carelessness on their part. Thus, the Minister is required to establish on a balance of probabilities that the Appellants did not exercise reasonable care in the completion and filing of their returns which caused misrepresentations to be made. [8]

Counsel for the Appellants submitted that the Minister’s failure to reassess within the prescribed periods of time did not arise solely from their misrepresentations. He argued that the legislative policy limiting the Minister’s right to reassess beyond the normal reassessment period was designed to strike a balance between the Minister’s need to have time to properly consider and assess the taxpayers’ information and the taxpayers’ need to have certainty in his tax affairs. Because of this policy, the Minister is entitled to reassess beyond the normal reassessment period only if the information required by the Minister is flawed or unavailable due to neglect, carelessness or a more serious deficiency by the taxpayer. Since in this case throughout the normal reassessment period, Revenue Canada had before it all the information needed to correctly assess the Appellants, had it exercised its prerogative to review the returns during this period, it would have discovered the problem and would have been able to compute the correct income without any further input from the Appellants. Reference was made to the comments of MacGuigan J.A. in Regina Shoppers Mall Ltd.? [9] who considered in that case the fact that the Minister was possessed of all of the necessary information to reassess within the normal reassessment period and commented:

It is quite clear from the evidence that the failure to reassess in time was not due to any misrepresentation on the part of the plaintiff (the taxpayer) but simply a total failure on the part of the defendant (the Minister) to consider the information which it had before it....

The circumstances in Regina Shoppers Mall Ltd. are substantially different than those raised in the present appeals. The facts in that case (as summarized in the headnote), were:

The taxpayer disposed of a piece of real estate in 1976 and treated the proceeds as a capital receipt, claiming a reserve. The Minister assessed the receipt as income, allowing a reserve on that basis. The taxpayer appealed. The appeal was finally resolved on September 21, 1989 when the Federal Court of Appeal rendered its judgment in favour of the Minister. In the meantime, the taxpayer continued to file on the capital basis. For the year 1979, the Minister reassessed in 1980 on the basis that the gain was income. The taxpayer objected, claiming that the reassessment was statute-barred or, in the alternative, it should have allowed a reserve. The Minister reassessed again to allow such a reserve. The taxpayer then successfully appealed on the ground that the reassessment was statute- barred. The present case was an appeal from that decision of the Trial Division. The Crown argued that the taxpayer should either have filed on the basis of the Minister’s contention or, alternatively, should have filed as it did with the waiver of the four-year limitation on reassessment. The Minster (sic) also reassessed the 1980 year on the ground that the taxpayer omitted the carry-forward of the reserve the Minister had claimed as remaining from 1979.

The issue before the Court was whether the reassessment for 1979 was in fact statute-barred as being over four years after the date of the original assessment and that depended entirely on whether the plaintiff in filing its T2 return for that year, made any misrepresentation attributable to either neglect, carelessness, wilful default or fraud. It is in that context that MacGuigan J.A. cited with approval the following comment of Addy J. of the Federal Court Trial Division:

It is quite clear from the evidence that the failure to reassess in time was not due to any misrepresentation on the part of the plaintiff but simply to a total failure on the part of the defendant to consider the information which it had before it. The witness for the defendant admitted that the Department by mistake or for some unknown reason failed to follow its normal procedure when there is continuity of reserves, until after the four-year period has expired. This was not a question of having to dig into old files but, on the contrary, the whole issue was being vigorously contested. There was a note made on the file of the Department when the 1976, 1977 and 1978 years were reassessed that the matter should be followed in later years. This in fact was done for 1980 but was not done for 1979. I fully accept the evidence of the experts called on behalf of the plaintiff to the effect that it was proper practice for the plaintiff to file as it did. The defendant has failed to discharge the onus that, in the filing of the 1979 return, there was any misrepresentation attributable to neglect, carelessness or wilful default or fraud on the part of the plaintiff or its agent.

(Emphasis added)

Given the fact situation therein, it comes as no surprise that both the Trial Division and the Court of Appeal concluded that the failure to reassess was not due to misrepresentation on the part of the taxpayer and held that the 1979 and 1980 years were statute-barred.

This decision does not stand for the proposition that there is some obligation on the Minister to review each return in detail to ascertain whether the true facts could have been determined prior to the expiry of the limitation period. In this context, it is useful to consider the comments of the Federal Court of Appeal in Nesbitt v. R. [10] . In that case, the Appellant argued there could be no operative misrepresentation for the purposes of subsection 152(4) because by the time of the expiry of the four-year limitation period, the Minister was actually aware of the mistake in the Appellant’s 1981 return. In dealing with that submission, Strayer J.A. made the following comment:

Even assuming that the letter of August 6, 1986, could be taken to prove the Minister’s knowledge by that date (two months prior to expiry of the four-year limitation period) of the true facts and that there had been a misrepresentation, I do not believe this assists the appellant. 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. Il would undermine the self-reporting 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.

(Emphasis added)

I turn next to the Appellants’ primary contention that while mistaken, they acted honestly and diligently to the best of their abilities in the face of extremely complicated provisions of the Act and in so doing met the standard of care required of taxpayers for the purposes of subparagraph 152(4)(«)(i). With respect to the requisite standard of care, Counsel for the Appellants argued that this is not a tort case where an accountant held himself out to be an expert in taxation and a client relied on that expertise. In this instance, it was suggested that Strawson prepared his return in his capacity as a taxpayer possessed with no special tax knowledge and that accordingly, his, (and Fukushima’s) conduct must be judged in the context of those limited skills.

The Minister is required to prove at a minimum that an error has been made by the taxpayer and while it may have been made in good faith, it was nevertheless not one which a normally wise and cautious taxpayer would have committed. This principle must be considered in the context of a taxpayer’s experience with accounting and tax matters and capacity to fully understand the details of a provision of the Act. Let me state at the outset that I do not subscribe to the proposition that because the Appellants are chartered accountants and a mistake has been made on their respective tax returns, ipso facto, the mistake is a negligent or careless mistake. I believe it is fair to say that the jurisprudence recognizes an element of subjectivity in the application of subparagraph I52(4)(«)(i) [11] and that the requisite standard of care in this case is that of the reasonably competent accountant who is a general practitioner but not a tax specialist.

In the present case, although neither Appellant professes to be a tax specialist, each regularly dealt with income tax matters in their accounting practice, which according to Strawson included tax advice, and throughout the years clearly held themselves out as capable of attending to the preparation of financial statements and the requisite income tax returns for both their corporate and personal clients. Because of this expertise, there must be attributed to them a relatively higher degree of understanding of taxation principles. In my view, a chartered accountant in circumstances such as this is bound to fulfil his duty with respect to the preparation and filing of his own income tax returns with the same care and skill that his clients are entitled to expect if he were providing a similar service for them.

It is not disputed that the behaviour of a taxpayer will not fall within the scope of the phrase “a misrepresentation attributable to neglect, carelessness or wilful default” if the taxpayer has exercised reasonable care. The Appellants, in my view, have not demonstrated a reasonable effort in the circumstances and within their own framework of comprehension and competence with respect to the proper computation of their income for tax purposes following an election pursuant to section 34 of the Act. No single factor leads me to this conclusion, rather it is the cumulative effect of all of the evidence.

As previously observed, the Appellants are reasonably competent accountants who held themselves out to the public at large as such. They are expected to possess knowledge of the basic principles of tax law which are commonly known by reasonably well-informed accountants and to discover and consider other aspects of tax provisions which may readily be found by the careful application of standard research techniques. In my view, the evidence of Strawson falls short of satisfying me that was done. Indeed, it is somewhat surprising that Strawson was unable to reach the rather straightforward conclusion that the section 34 election provides nothing more than a deferral of income and not a permanent deduction.

I was not favourably impressed by Strawson’s testimony. He attempted to denigrate his experience and skill as an accountant particularly as it related to income tax matters. He attempted to justify his course of conduct by blaming the forms and argued that Revenue Canada should bear the brunt of any blame if misrepresentation had occurred since the problem had existed since 1982 and therefore, Revenue Canada did not need to audit the partnership and had the full information in its possession. Strawson would also have the Court accept that his concerns in 1982 or 1983 respecting the application of section 34 were substantial. However, there is no evidence that he discussed these concerns with Fukushima who was, according to Strawson, “one of the better all-round accountants in Thunder Bay”, this notwithstanding the fact that Fukushima had recently brought to Strawson’s attention the inappropriateness of his treatment of WIP. If, as Strawson said, he was perplexed and confused by the relevant provisions and considered the issue to be beyond his tax expertise, his failure to seek the advice of Fukushima or of a tax specialist raises a serious question as to whether he bestowed proper attention and care upon the function he was performing for the partnership. Strawson also made much of the fact that he reviewed a commercial client’s file for comparison purposes. Since section 34 of the Act provides special rules for “designated professional businesses” and specifically defines that term the selection of a rental company for comparison purposes seems to be an odd choice.

Last, although the Appellants agree that the law cannot be overridden by an administrative pronouncement, they argue that complexity is a factor which should be taken into account in determining whether the standard of care test has been met. The Appellants say they relied on administrative publications such as Interpretation Bulletins and Information Circulars. More specifically, Strawson made reference to Interpretation Bulletin IT- 457R which he says does not deal with the issue of adding back the prior years’ work in progress and does not describe the methodology to be applied. Furthermore, they assert that Revenue Canada not only failed to properly assist them with this difficult issue but rather made the problem worse since the forms provided to assist professionals using the election under section 34 of the Act were at a minimum, unhelpful and at worst, misleading and, while not causing the error, perpetuated it and the misunderstanding the Appellants had with respect to section 34.

Several observations are warranted. First, the forms tendered in support of this submission were for the 1987, 1988, 1995 and 1996 taxation years. Their relevance for this purpose is questionable since the Appellants do not dispute that the misrepresentations in issue first occurred in the returns they filed for the 1982 or 1983 taxation years and that they continued to follow the same erroneous methodology in each and every year thereafter without further thought or concern. The Appellants also do not dispute that they would likely have done so regardless of the forms.

It must be noted that subsection 34(1) was amended and renumbered by 1985, c. 45, ss. 13(1) applicable to the 1985 and subsequent taxation years. At the same time, subsection 34(2) was repealed. While the principal thrust of both was the same, i.e. to permit a taxpayer carrying on a professional business to elect not to include in his income for a taxation year an amount in respect of work in progress, the language used is substantially different. [12] I find little merit in the submission that the complexity of the provisions or that the “limited direction, if not misdirection”, provided by the Respondent renders it inappropriate for the Respondent to now allege negligence or carelessness by the Appellants.

Some additional comments with respect to the appeal of Fukushima are warranted. He chose not to testify and is prepared to rest his case on Strawson’s testimony. Nonetheless, he is the taxpayer/Appellant and I must determine whether he exercised reasonable care in the completion and filing of his returns. In this case, he was the person who raised the issue of taking WIP into account shortly after he entered the partnership. This, at the very least, suggests an understanding of the fact that they were carrying on a professional business within the meaning of section 34 of the Act and that their record-keeping should be consistent for both financial and income tax recording and reporting purposes. The only inference that can be drawn is that from the very beginning Fukushima chose to rely on Strawson and accepted his computation of partnership income for tax purposes without question. If that was the case and there is no evidence to the contrary, then with respect to the misrepresentation, that is of itself an indicator of neglect and carelessness. As was observed by Rouleau J. in Can-Am Realty)^ [13]

Furthermore, as pointed out in the Venne decision, it is the taxpayer himself who carries the ultimate responsibility for ensuring his tax returns contain accurate data. That obligation is not altered by the fact that the taxpayer has engaged the professional services of an accountant or other agent to prepare and complete his returns....

This principle equally applies in the present appeal. There is no evidence that Fukushima made a review of his partnership income tax returns with specific reference to the computation of his income utilizing the modified accrual method. His failure to do so demonstrates that a reasonable effort was not taken by him in the circumstances and within his own framework of comprehension and competence.

1 am satisfied that the Respondent has established that the Appellants did not exercise reasonable care in the completion and filing of their respective returns which caused misrepresentations to be made. The appeals are dismissed, with costs.

Appeal dismissed.