David I Guttman v. Minister of National Revenue, [1979] CTC 2223, 79 DTC 243

M J Bonner:—This is an appeal from an assessment made April 26,1977, of a penalty under subsection 163(2) of the Income Tax Act in respect of the appellant’s 1972 tax return. The burden of proof of the facts justifying the imposition of the penalty is, under subsection 163(3) of the Act, on the respondent.

The respondent, in the reply to the notice of appeal, pleaded:

(a) the appellant is an accountant and earned the bulk of his income from a professional accounting practice and knew or ought to have known that he must keep books and records of account in such form and containing such information as would enable to be determined the taxes payable under the Income Tax Act for the 1972 taxation year;

(b) the appellant failed to keep his books and records of account in such manner as would enable the taxes payable for the 1972 taxation year to be determined, or, alternatively, relied on his partner for whose actions he is responsible to keep such books and records;

(c) the amount of unreported taxable income for 1972 ($3,244.68) in relation to his total taxable income ($12,142.56) was very substantial (26.7%).

It will be seen that the reliance by the appellant on the actions of his partner is central to the issue in this appeal. it would therefore be appropriate at this point to refer to the decision of the Exchequer Court in Cyrus C Udell v MNR, [1969] CTC 704; 70 DTC 6019, and in particular to the following passage from the reasons for judgment of Cattanach, J, at 713 and 714 [6025 and 6026:]

Accordingly there remains the question of whether or not section 56(2) contemplates that the gross negligence of the appellant’s agent, the professional accountant, can be attributed to the appellant. Each of the verbs in the language ‘participated in, assented to or acquiesced in’ connotes an element of knowledge on the part of the principal and that there must be concurrence of the principal’s will to the act or omission of his agent, or a tacit and silent concurrence therein. The other verb used in section 56(2) is ‘has made’. The question, therefore, is whether the ordinary principles of agency would apply, that is, that what one does by an agent, one does by himself, and the principal is liable for the actions of his agent purporting to act in the scope of his authority even though no express command or privity of the principal be proved.

In my view the use of the verb “made” in the context in which it is used also involves a deliberate and intentional consciousness on the part of the principal to the act done which on the facts of this case was lacking in the appellant. He was not privy to the gross negligence of his accountant. This is most certainly a reasonable interpretation.

In short I am of the view that if the respondent is to succeed in this appeal he must bring home to the appellant the deficient state of mind required by subsection 163(2).

From September of 1968 to September of 1973 the appellant carried on the practice of a chartered accountant with Edward John Court under the firm name Court, Guttman & Co. The firm kept its domestic accounts on the accrual basis. Before 1972 the firm reported income for tax purposes on the cash basis. The revenues of the firm were recorded on the basis of billable time converted to dollars by application of a billing rate. The pre-1972 process of conversion for tax purposes to the cash basis involved the elimination from revenue thus determined of amounts which represented unbilled time and accounts receivable. The amendments to the Income Tax Act effected for 1972 required that the appellant’s income from the partnership be calculated in accordance (inter alia) with section 34 of the Act and section 23 of the Income Tax Application Rules.

In 1972 and 1973 the partnership financial records were maintained by the appellant’s partner, Mr Court. The records kept included a cheque book, deposit books, invoices, work in process records, a general ledger and a synoptic. After dissolution of the partnership Mr Court kept the partnership financial records in his possession, even though the dissolution was not on amicable terms. The appellant’s 1972 income from the partnership was reported by the inclusion in his return of a profit and loss statement and a balance sheet for the period ending August 31, 1972. Both the statement and the balance sheet were prepared by Mr Court.

In April of 1975 the respondent demanded production by the appellant of the books and records of the partnership. The appellant was apparently advised by Mr Court that the latter had turned the books and records over to the respondent. The appellant so informed the respondent. The respondent was questioning the accuracy of the appellant’s return and so the appellant attended at the respondent’s offices to examine the material seized from Mr Court. He was assisted in the examination by William Green, his new partner. The appellant and Mr Green were unable to find any working papers or the general ledger or the synoptic pertaining to 1972. The two attempted to determine from the material available whether the partnership financial statements included with the appellant’s return were accurate. They discovered several deficiencies, two of which are material to this appeal.

The first deficiency arose in the following manner. On the profit and loss statement revenues reported included “Fees—$122,977.06”. Expenses were deducted giving rise to a net income figure. There was then deducted “Work in Process—$19,057.50”, thus producing an amount reported as “Net Income for Tax Purposes”. The balance sheet showed, as a current asset, “Work in Process—$19,057.50”. It was discovered that the amount reported for 1972 as “Fees” did not include, as it had in past years, any amount for unbilled work in process and thus the deduction on the profit and loss statement of the $19,057.50 was wrong.

It should be noted that the work in process deduction was not, on the face of the statements, wrong nor likely to give rise to suspicion. The appellant testified that he assumed that Mr Court had prepared the profit and loss statement on the same basis as in the past, namely, on the basis that the revenue item described as “Fees” included amounts in respect of unbilled time. The error could only have been discovered by an examination of the partnership financial records or the working papers. The appellant testified that he had, at the time he reported his income based on the financial statements prepared by Mr Court, no reason for believing that Mr Court was incompetent. The only conclusion which could be reached by Mr Guttman and Mr Green in relation to the wrongful deduction of the $19,057.50 was that in all probability Mr Court had understated the drawings by that amount in order to make the balance sheet balance. The appellant was unable to say whether the understated drawings were his or those of Mr Court. Mr Court was not called as a witness.

A second deficiency in the statements filed with the appellant’s return of income which resulted in understatement of income was the omission to include, in computing income, the 1971 work in process, an inclusion required by paragraph 23(3)(c) of the Income Tax Application Rules. The respondent’s position was that the omission could only have resulted from gross negligence because the inclusion of this item was not a technical adjust- ment, but rather was one very closely related to basic accounting theory as applied to the operation of converting from cash basis accounting to accrual basis accounting. While I have no difficulty with the proposition that the appropriate amount should have been included, it does not appear to me to have been established on the evidence that it must necessarily have been included as a separate and distinct item. In other words, given the rather cryptic descriptions in the profit and loss statement prepared by Mr Court the appellant might well have concluded, without being grossly negligent, that both this figure and the figure for the 1972 work in process were included in the fees reported. At least in the circumstances disclosed in evidence in this case I can find no basis for suggesting that the appellant was grossly negligent in failing to, in effect, audit the statements prepared by his partner.

On this analysis I cannot find that the appellant himself was grossly negligent and in light of the decision in Udell v Minister of National Revenue (supra), I must allow the appeal. There plainly was, to put it charitably, gross negligence, but on the evidence before me I cannot find that it was the gross negligence of the appellant. The appeal will therefore be allowed the assessment referred back to the respondent for reconsideration and reassessment on the basis that the appellant is not liable to the penalty assessed.

Appeal allowed.