Lambert & Grenier Inc v. Minister of National Revenue, [1979] CTC 2929, 79 DTC 486

Guy Tremblay [TRANSLATION]:—This case was heard at Montreal, Quebec on August 29, 30 and 31, 1978, jointly with the case of Denis Lambert (77-283), Roger Lambert (77-284) and Joseph B Grenier (77-866).

1. Points at Issue

(A) The question is whether the respondent is correct in including in the appellant’s income for the taxation year 1973 the sum of $83,522.65 as unrecorded sales.

(B) The respondent included $22,704.80 in the appellant’s income for the taxation year 1974 as disallowed expenses ($18,745.47) and unrecorded sales ($3,959.43), thereby reducing the loss of $93,235.09 declared by the appellant for 1974, and because of the rule on application of losses thus increasing the taxable income for 1973.

(C) The respondent disallowed the appellant’s argument that certain depreciable assets were classified in Class 10 by error, instead of in Class 22, and additional amounts of $5,187.63 and $5,989.53 should accordingly be allowed as capital cost allowances for 1973 and 1974 respectively.

(D) Finally, a penalty of $3,543.66 was imposed on the appellant for 1973 for fraud or gross negligence.

2. Burden of Proof

The burden is on the appellant to show that the respondent’s assessments are incorrect. This burden of proof derives not from one particular section of the Income Tax Act, but from a number of judicial decisions, including the judgment delivered by the Supreme Court of Canada in R W S Johnston v MNR, [1948] CTC 195; 3 DTC 1182.

3. Facts

(A) General facts

3.01 The appellant company was incorporated in 1964 with the primary purpose of construction. Ordinarily, the work consists of the building of bridges and viaducts.

3.02 The principal shareholders are Messrs Joseph B Grenier (50%), Denis Lambert (25%) and his brother Roger Lambert (25%). These three people had worked together in the construction field before the incorporation. Inter alia, in 1959 they had built and kept for themselves the motel-restaurant “Le Roi du Steak” in Notre-Dame du Bon-Conseil parish, Quebec. located ten miles from Drummondville, and in 1963, the “Quatre Saisons” motel in the village of Notre-Dame du Bon-Conseil.

3.03 Both the above motels became the property of “Les Entreprises Lambert Inc” in 1964. The two principal shareholders in this company are Miss Alice Lambert (51 %), who is the manager and in practice makes all the decisions, and her brother Mr Roger Lambert (49%).

3.04 At the end of 1971, the Quatre Saisons motel suffered an extensive fire (leaving only 16 motel units), and it was decided early in 1972 not to rebuild but to expand the “Roi du Steak” motel-restaurant located five miles from the first motel. According to Miss Alice Lambert, plans were prepared to this end by Martin Décoration.

(B) The unrecorded sum of $83,522.62—1973

3.05 As Les Entreprises Lambert Inc wanted to know the cost of the expansion work, it had an estimate prepared by Mr Denis Lambert, the appellant’s manager. This estimate was dated February 17, 1972 and totalled $232,516, $40,694.60 of which was for furnishing eight units in the motel, $45,000 for furnishing “other than motel units”, $4,000 for plans and $3,000 for plumbing “other than motel units”. This estimate was filed as Exhibit I-8.

3.06 On March 8, 1972 the appellant made a bid in the amount of $125,000 (Exhibit A-2) for building the expansion, and submitted it to Les Entreprises Lambert Inc in the following form:

BID

Renovation and expansion of your motel “LE ROI DU STEAK” located at Exit No 118 of the Trans-Canada Highway at Notre-Dame du Bon-Conseil.

ONE HUNDRED AND TWENTY-FIVE THOUSAND DOLLARS $125,000

NOTE—This work will be done as agreed with you.

Lambert & Grenier Inc

By: Denis Lambert

ACCEPTANCE

Accepted by Alice Lambert

The evidence showed that the work referred to by this bid consisted of foundations, walls and roofing for eight motel units and an additional area to accommodate twelve tables for dining.

According to Miss Lambert, no other bid was requested from other contractors for this work.

3.07 On March 20, 1972 another bid amounting to $259,600 (Exhibit A-1) was also submitted by the appellant to Les Entreprises Lambert Inc. According to Miss Lambert, this bid for the work as a whole was prepared at the request of the Roy Nat financial institution, from which Les Entreprises Lambert Inc had requested financing. This document stated that the figures had been established in accordance with the plans and specifications.

3.08 The financing of the expansion was as follows: $100,000 from compensation received from fire insurance, resulting from the fire occurring at the Quatre Saisons motel in December 1971; $135,000 from Roy Nat; and $25,887 in credit obtained from Grenier Elictrique Enrg. This business was the property of Mr Joseph B Grenier, the appellant’s principal shareholder.

3.09 The payments were as follows: $125,000 to the appellant, $25,887 to Grenier Enrg and $97,805 to various suppliers or subcontractors, a list of whom was filed as Exhibit A-1(2).

3.10 According to Miss Lambert, the work took a long time. It began in April 1972 and ought to have ended in October 1972. According to Mr Denis Lambert, the appellant thought the work would have been completed by the end of May 1972. However, because of various circumstances (frost, rocks), it was not completed in May or even in October 1972, but went on until February or March 1973.

3.11 Late in 1972, according to Miss Lambert, she was told by her brother Denis that the cost of the work would exceed the stated bid by $70,000 to $80,000. She replied that she would only pay the amount of the bid, $125,000. This was a set amount. Furthermore, she had no financing to pay any more.

3.12 According to Mr Denis Lambert, the additional cost was due not to additional work requested by Les Entreprises Lambert Inc, but primarily to the following facts:

(a) the bid had been prepared essentially on a cost per square foot basis, and this was not a good basis in cases of this kind;

(b) in preparing the bid he had allowed a lower profit, namely 5 or 6% only; Mr Lambert had taken into consideration the fact that the site was close by and thus made transportation of materials and labour easier; moreover, it was the slack spring period, and this was important especially in keeping workmen;

(c) the excavation encountered problems with rocks and ground frost that were greater than expected;

(d) the foundation was lower than the existing portion, and it was necessary to support the existing foundation by scaffolding;

(e) as the foundation was not at the same level, unforseen problems also appeared;

(f) inclement weather also caused special problems in joining the new building as a whole to the old one.

3.13 The cost of the additional work was established before the Board by means of the respondent’s claim of $83,522.65 in his notice of assessment of December 31, 1975. According to Mr Jean Marc Labbe, this amount was assessed because, at the end of fiscal year 1973, that is at January 31,1973, this balance remained after analysis of the accounting statements submitted by the appellant company to Les Entreprises Lambert Inc (Exhibit I-4). This receivable is regarded by the respondent as income. The appellant was operating on the accrual system of accounting.

3.14 Moreover, the appellant company admitted that work was done for this amount and that statements of account had been submitted to Les Entreprises Lambert Inc in addition to the sum of $125,000. However, the appellant denied that this was an account receivable and so taxable.

3.15 According to Mr Denis Lambert, at the end of 1975 an opinion was requested from a law firm in Drummondville regarding the possibility of collecting this account from Les Entreprises Lambert Inc. This opinion, which was filed as Exhibit A-3 and dated February 2, 1976, was that such a claim against Les Entreprises Lambert Inc was without basis in fact or in law, especially as no additional work had been done besides that agreed between the parties. This opinion was primarily based on Art 1690 of the Civil Code of the province of Quebec.

3.16 In filing its 1973 tax return, the appellant declared a net income of $41,374.49. In issuing the notice of reassessment dated October 8, 1975, the respondent added the sum of $254,025.65, broken down as follows:

(C) The sum of $22,704.90

3.17 In filing its tax return for 1974 the appellant declared an operating loss of $93,235.09. As a result of certain deductions and adjustments, the loss was reduced to $58,992.23, in accordance with the following detailed statement:

Of the amounts deducted, only the sum of $22,704.90 is on appeal.

3.18 This sum of $22,704.90 includes $18,745.47 of disallowed expenses and $3,959.43 of unrecorded sales.

3.19 The respondent moved to dismiss the appeal as to the year 1974. As the appellant withdrew its appeal, it was agreed that if the amount of $22,704.90 is allowed it will increase the 1974 loss and so be applicable against taxable income for 1973.

3.20 With reference to the sum of $18,745.47, the respondent filed Exhibit 1-1, 15 to 20, six invoices issued by J B Grenier, electrical contractor, to the appellant for work done between September 18, 1973 and November 26, 1973. These expenses were disallowed by the respondent.

3.21 The work done is described, inter alia, as follows:

Each of these descriptions of the work is followed by description’s of the material used, the number of hours and the number of workers, transportation and meals, and the cost applicable to each item.

3.22 All these invoices are referred to in a document (Exhibit I-2) seized at the residence of Mr J B Grenier, one page of which (filed at p 28 of Exhibit 1-1) is titled “Withdrawn in 1973”. Reference may be made to the reasons for judgment in Lambert and Grenier v MNR, (77-283, 77-284 and 77-866), at paragraphs 3.26 and 3.27, for the breakdown of the amounts of these invoices between the shareholders.

3.23 The amounts of these invoices are again referred to in the deposit slip (Exhibit 1-6) of Mr Grenier’s personal bank account (0-319-25). From the total deposit made he withdrew a substantial amount, leaving a net deposit corresponding to his share, as recorded by Mr Grenier in Exhibit I-2, on the page entitled “Withdrawn in 1973”.

3.24 A witness for the respondent, Mr Serge Bouchard, who filed the six invoices as Exhibit 1-1-15, noted that the business title “Grenier Electrique Enrg” stamped on the top of the invoice had been struck out on all six invoices. These deletions were an important factor in the respondent’s decision to regard the invoices as false, Mr Bouchard said.

3.25 No evidence was submitted by the appellant regarding the amount of $3,959.43.

3.26 At paragraph 10(h) of the reply to the notice of appeal the respondent alleged, referring to the amounts of $18,745.47 and $3,959.43, that “these amounts represent amounts paid to Mr J B Grenier, a shareholder of the appellant, by the appellant”.

3.27 Mr J B Grenier did not testify. He was in fact not working for the appellant, according to Mr Denis Lambert.

4. Act—Case Law—Comments

4.1 Act

The principal sections of the new Act involved in the case at bar are 3,9, paragraph 18(1)(a), section 111 and subsection 163(2). They will be cited at length, if necessary, during the comments.

4.2 Case Law

The case law and legal theory referred to by the parties are cited below:

BUILDER’S OBLIGATION

1. Charles Garceau and Maurice R Ouellette, [1960] SCR 668;

2. Towstuck v Brisebois, [1948] QB 292;

3. Cité de St-Laurent v Jacques Boudrias, [1974] CA 473;

4. Dame Parthenais v Kozlowski, [1949] RL 357;

5. Roderick W S Johnston v MNR, [1948] CTC 195; 3 DTC 1182;

6. Mathers et Les Carrières St-Eustache v Pelletier Handling Equipment Co Ltd, [1970] CA 1;

7. R Martel Construction Ltée v Office Municipal d’Habitation de Maniwaki, [1970] CS 501;

8. Pavage Montclair Inc v H Blackburn Compagnie Ltée & Le Registrateur de la Division d’Enregistrement de Hull, [1975] CS 988;

9. St-Romuald Milling v Drouin, [1972] CA 438;

10. Kenneth B S Robertson Ltd v MNR, [1944] CTC 75; 2 DTC 655;

11. Frank Sura v M N R, [1962] CTC 1; 62 DTC 1005;

12. MNR v Col fold Contracting Co Ltd, [1960] CTC 178; 60 DTC 1131;

13. Maple Leaf Mills Ltd v MNR, [1976] CTC 324; 76 DTC 6182;

NOTICE

14. Arsenault v Union Insurance Society of Canton Limited, [1961] QB 59;

15. Bélair v LaSalle et autres, [1970] CA 275;

16. Veuve Clément Bouchard & Euclide Bouchard es qualité v Diane Lepire, [1974] CA 616;

17. Bourdon v Hudson Bay Insurance Co, [1934] 72 CS 146;

18. London and Midland General Insurance Company v Olivia Galarneau, [1976] CP 8;

19. Ginette Pie v Robert Thibert et autres, [1976] CS 180;

20. Sigouin v Dame Ouellette et vir, [1949] CS 48;

21. Union Insurance Society of Canton Limited & André Arsenault, [1961] SCR 766;

22. La Preuve, Léo Ducharme, avocat, professeur à /’Université d'Ottawa (1977), RB 512;

CORROBORATION

23. George Basha v MNR, 31 Tax ABC 417; 63 DTC 375;

24. Bruce A Carey v MNR, 17 Tax ABC 97; 57 DTC 215;

25. Vicenzo Curcio v MNR, [1978] CTC 2076; 78 DTC 1097;

26. Alex Markowitz v MNR, 35 Tax ABC 348; 64 DTC 397;

27. Joseph Philliponi Jr v M N R, [1951] CTC 255; 51 DTC 528;

28. William Henry Phillips v M N R, 3 Tax ABC 177; 51 DTC 12;

29. Claude Piette v MNR, judgment CRI 21/6/78;

30. Vahan Tashdjian v MNR, 5 Tax ABC 171; 51 DTC 404;

31. MNR v William S Walker, William S Walker v MNR, [1951] CTC 334; 52 DTC 1001;

32. Jack Ying v MNR, 19 Tax ABC 449; 58 DTC 430;

33. No 146 v MNR, 10 Tax ABC 99; 54 DTC 117;

34. No 230 v MNR, 12 Tax ABC 136; 55 DTC 74;

35. No 566 v MNR, 20 Tax ABC 289; 58 DTC 597;

36. No 573 v MNR, 20 Tax ABC 436; 58 DTC 706;

JURISDICTION

37. Jack Abugov v MNR, [1972] CTC 2598; 72 DTC 1493;

38. Benaby Realties Limited v MNR, [1965] CTC 273; 65 DTC 5161;

39. Forand Auto Ltée v MNR, 40 Tax ABC 302; 66 DTC 184;

40. Eugène Lagacé <& George Lagacé v MNR, [1968] CTC 98; 68 DIC 5143;

41. Helen J Lenglet v MNR, [1969] Tax ABC 129; 69 DTC 146;

42. No 409 v MNR, 16 Tax ABC 409; 57 DTC 137;

PENALTIES

43. Her Majesty the Queen v William Baziuk, [1976] CTC 787; 77 DTC 5001;

44. Paul E Gagné v MNR, [1978] CTC 2458; 78 DTC 1336;

45. Réginald Paillé v MNR, judgment CRI 1/8/78;

46. Fernand Renaud v MNR, [1976] CTC 2233; 76 DTC 1179.

THEORY—BUILDER’S OBLIGATION

Faribault— Traité de Droit Civil du Québec, pp 415-467;

Mignault—Section IV—De L’Ouvrage par Devis et marchés, pp 401-420.

4.3 Comments

(A) The sum of $83,522.65—1973

4.3.1 Based on the evidence submitted by the appellant and described in paragraphs 3.04 to 3.15 of the facts, the Board has arrived at the initial conclusion that the appellant did work for which it was never paid. This work amounted to $83,522.65 (see paragraph 3.13 of the facts). This evidence was not contradicted, including that regarding the explanation (see paragraph 3.12 of the facts) of the causes of the additional costs added to those in the bid (see paragraph 3.06 of the facts).

4.3.2 The Board must decide whether this debt was due to the appellant. In our view the legal opinion of February 2, 1976 was correct.The applicable provision is Art 1690 of the Civil Code, which reads as follows:

When a architect or builder undertakes the construction of a building or other works by contract, upon a plan and specifications, at a fixed price, he cannot claim any additional sum upon the ground of a change from the plan and specifications, or of an increase in the labour and materials, unless such changes or increase is authorized in writing and the price thereof is agreed upon with the proprietor, or unless the agreement upon those two points be established by the decisory oath of the proprietor.

This case involves an “absolute” lump sum contract, because the proprietor did not reserve the right to amend the plans. Accordingly, Art 1690 of the Civil Code applies. Judging from the testimony of Miss Lambert (see paragraph 3.04 of the facts), these plans did exist: they were mentioned in the legal opinion. The plans were not filed as an exhibit. However, Exhibit I-8 indicated (see paragraph 3.05 of the facts) that these plans cost $4,000. The existence not only of the plans but of the specifications as well may be seen from examining Exhibit A-1 (See paragraph 3.07 of the facts). Furthermore, the legal opinion cited Faribault, who argues that the specifications are only an accessory to the contract and do not always exist.

Finally, the additional cost were not due to additional work requested by Les Entreprises Lambert Inc, but merely to a faulty estimate of the costs. Art 1690 of the Civil Code is clear. The Board examined the case law cited by the respondent in this regard, but found nothing fundamental that might impair the validity of the legal opinion.

4.3.3 Since the debt of $83,522.65 was not owed by Les Entreprises Lambert Inc, it follows that it was not receivable by the appellant. The appellant believed that it was owed. Assuming that this belief could have had some effect on its existence as an account, then at the very least it would have become a bad debt after the legal opinion was given. If it became a bad debt in February 1976, then it can also be said at the very least that before that time it was a doubtful debt, and was so on January 31,1973. The appellant did not mention this fact in its notice of appeal. However, because of subsection 9(2) of the Act creating the Board, the latter is empowered to decide that the amount of $83,522.65 is deemed to have been claimed as a doubtful debt by the appellant on January 31, 1973. If the Board did not arrive at such a decision, the appellant would merely have to appeal to the Federal Court of Canada and mention it in its appellate pleadings. Quite apart from these comments on the doubtful debt, the Board is of the opinion that the debt did not exist at law and therefore it could not have any existence from an accounting point of view either. The fact that it had no existence at law made it non-existent at the end of the appellant’s 1973 fiscal year, namely at January 31, 1973.

(B) The sum of $22,704.80

4.3.4 Expenses disallowed: $18,745.47

In our opinion the work relating to the expenses and the amounts relating thereto as described are justified (see paragraph 3.21 of the facts). Moreover, the respondent admitted that these amounts had been paid (see paragraph 3.23 of the facts). However, the respondent disallowed the expense on the ground that this work was not done and the transfer to the shareholders was not a bona fide transaction within the meaning of subsection 15(1). Mr J B Grenier did not testify on this point. The appellant’s manager, Mr Denis Lambert, who testified in the case, did not provide any testimony on the point in question.

The reference to these invoices in other documents (Exhibits I-2 and I-6—see paragraphs 3.22 and 3.23 of the facts) would seem to support the validity of the invoices. However, although the respondent had all these items in his possession, he denied their validity by his notice of reassessment indicating that the transaction was not a bona fide one. Evidence by the appellant was called for. In the Board’s view this evidence would have been easy to provide; even the appellant’s manager did not see fit to do so. It must have been difficult, or he forgot it.

The presumption that the assessment is correct therefore remains intact: it has not been rebutted. The expense is disallowed.

4.3.5 Unrecorded sales: $3,959.43

As no evidence was presented by the appellant, the burden of proof was not shifted. The assessment is upheld.

(C) Capital cost allowance: $11,177.16 (1973 and 1974)

4.3.6 During the hearing the respondent admitted the validity of the claim of $5,187.63 for 1973 and $5,989.53 for 1974 (thus increasing the 1974 loss) as a capital cost allowance on certain depreciable assets.

(D) Penalty

4.3.7 It is clear that the penalty provided for in subsection 163(2) of the new Act cannot be imposed on the sum of $83,522.43, or on that of $11,177.16, since the appeal is allowed on these points.

With regard to the amounts of $18,745.47 and $3,959.43, if the appeal has been dismissed in this regard because the appellant failed to present evidence, can the Board accept prima facie that there has been fraud or gross negligence? The burden of proof regarding the penalty rests on the respondent under subsection 163(3) of the new Act, and subsection 62(3) of the Income Tax Application Rules, 1971 (ITAR). It appears from the evidence presented by the witnesses for the respondent as a whole (and described in paragraphs 3.20 et seq of the facts, including the part of the reasons for judgment in Lambert, Lambert and Grenier, the evidence for which was joined to the case at bar, concerning the sum of $22,704.90, namely paragraphs 3.26 et seq of the facts), that this was a scheme deliberately perpetrated by the shareholders of the appellant to transfer a sum of money belonging to the company into their pockets, while at the same time claiming the amount as an expense in computing the company’s income. The penalty is upheld. Penalties have been upheld with a great deal less evidence in other cases.

8. Conclusion

The appeal is allowed in part and the whole referred back to the respondent for re-assessment in accordance with the above-stated Reasons for Judgment.

Appeal allowed in part.