Denis Lambert, Roger Lambert, Joseph B Grenier v. Minister of National Revenue, [1979] CTC 2952, 79 DTC 477

Guy Tremblay [TRANSLATION]:—These appeals were heard at Montreal, Quebec on August 29, 30 and 31, 1978 jointly with the appeal of Lambert & Grenier Inc (77-282).

1. Points at Issue

(A) 1970, 1971, 1972: Joseph B Grenier

The question is whether

(a) first, the assessment for 1970 is valid, since, as the appellant contended in his pleadings, it was made beyond the four years specified in subsection 152(4) of the new Income Tax Act;

(b) the sum of $174,919 (1970: $19,928; 1971: $19,928; 1972: $135,063) was properly included in the appellant’s income by the respondent, relying on the ‘‘net worth” method for 1970 and 1971 and the factual method, according to the respondent, for 1972.

(B) 1973: Denis and Roger Lambert

The question is whether in 1973 the appellants Denis and Roger Lambert, shareholders in Lambert & Grenier Inc, received from the company part of the sum of $22,704.90, namely $9,554.81 to Denis Lambert and $3,595.59 to Roger Lambert, other than through a normal transaction.

(C) Penalties

The question is whether the various penalties imposed by the respondent pursuant to subsection 56(2) of the old Income Tax Act and subsection 163(2) of the new Act, totalling over $13,000 are correct.

2. Burden of Proof

The appellants have the burden of showing that the respondent’s assessments are incorrect. This burden of proof results not from a particular section of the Income Tax Act, but from a number of judicial decisions, including the judgment of the Supreme Court of Canada in R RWS Johnston v MNR, [1948] CTC 195; 3 DTC 1182.

Additionally, in order to have the penalties upheld, the respondent has the burden of showing that the appellants committed gross negligence by filina their own tax returns erroneouslv for the ears in question. This burden results from subsections 163(2) and (3) of the new Act and subsection 62(3) of the Income Tax Application Rules, 1971.

3. Facts

(A) Joseph B Grenier: 1970-1971

3.01 Mr Grenier operates an electrical contracting business under the name of Grenier Electrique Enrg. He is its principal shareholder (50%) and is the director of Lambert and Grenier Inc. He is also a shareholder in the Escale hotel, and he is a shareholder with Messrs Denis and Roger Lambert.

3.02 The only witness for the appellant, Mr Charles Hébert, CA, stated that he had prepared the 1970 and 1971 tax returns using the net worth method. It was necessary for him to use this method because the accounting system was practically nonexistent. In addition, before he had finished preparing 1970, fire destroyed the existing documentation in December 1971. The initial notice of assessment for 1970 was issued on April 4, 1972. The notice of re-assessment was issued on May 23, 1975 (Exhibit 1-1-2 and 22).

3.03 The accountant then prepared Mr Grenier’s balance sheet at December 31, 1971, on the basis of which he determined his account for 1970 and 1971. At December 31, 1971, total assets were $132,950.04, and liabilities amounted to $79,549.47, leaving a net capital of $53,400.57.

Mr He’bert submitted a capital reconciliation as follows:

The amount of $21,078.99 was distributed as follows: net business income, 1970: $9,581.35; 1971: $11,497.64 (Exhibit 1-1, pp 66 and 76).

3.04 As a result of the inquiry conducted, the respondent prepared the balance sheet at December 31, 1971 as follows: total assets amounted to $195,467.76, while liabilities amounted to $100,149.56, leaving a net capital of $95,318.20.

The respondent submitted a capital reconciliation as follows:

3.05 The amounts added by the respondent to income are broken down as follows:

(B) Joseph B Grenier: 1972

3.06 The accountant Charles Hébert stated that he prepared the 1972 tax return using the net worth method: a net income of $25,836.12 was declared. He prepared the statements with the documents supplied to him.

3.07 Mr Hébert, the accountant, prepared the balance sheet to December 31, 1972. Liabilities totalled $146,021.56, including $71,090.38 net capital.

3.08 As the consequence of an inquiry, the respondent set adjusted income on a factual basis at $185,298.19, that is $135,063 of additional income.

3.09 The capital reconciliation was submitted as follows by the respondent’s accountant, Mr J M Labbe:

3.10 Mr Grenier’s accountant declared sales of $41,846.20 and gross profit of $8,613.41 for 1972 relating to the Escale hotel operation. However, according to Mr Labbé, the respondent’s accountant, sales amounted to $90,527.60 and gross profit to $47,497.02. As the respondent had established operating expenses at $50,333.05 and deducted them, a loss of $2,836.03 resulted. This loss was the subject of an adjustment in computing the capital reconciliation (see paragraph 3.09) (Exhibit 1-1, pp 81 and 106).

3.11 With regard to the appellant’s electrical contracting business, his accountant declared sales of $297,839.41 and a gross profit of $27,397.50 by the net worth method. By an initial calculation using the factual method he arrived at a net income of over $100,000, and in his submission this was too high and could not be explained, so he had used the net worth method. However, Mr Labbé arrived at sales of $449,503.34 and net profit of $163,824.41. After deducting administrative expenses of $16,955.30 and adding other income amounting to $16,866.59 (purchase discount: $975.43; interest: $171.66; salary and bonus from Lambert & Grenier Inc: $15,720), Mr Labbé set overall net income at $163,735.70 (Exhibit 1-1, pp 81 and 107).

3.12 Mr Labbé, the respondent’s accountant, maintained that following the seizure of 25 boxes of documents, a careful analysis and examination of the documents was conducted, and the income and expenditure statement was prepared using the factual method. Each item in the balance sheet was also checked.

3.13 The appellant’s accountant, Mr Charles Hébert, contended that from an economic standpoint it is not possible for a client’s accountant to devote the amount of time taken by Mr Labbe. Nonetheless, he prepared certain criticisms concerning the statements filed by the respondent.

3.14 The net profit from Mr Grenier’s electrical contracting business, established by the respondent without considering other income of $16,866.59, amounted to $146,869.11 ($163,824.41 gross profit less $16,955.30 administrative expenses—see paragraph 3.11). This net profit of $146,869.41 compared to sales of $449,503.34 gives a yield rate of over 30%. In his experience, the ordinary yield rate for a business of this kind is 10%. He stated that larger businesses, which have higher administrative expenses, have an even lower yield rate.

3.15 In Mr Hébert’s submission, with the appellant’s receipts and expenditures journal (Exhibit 1-10), and the resulting $25,800 of net income, it is logical to start with this figure and add expenses, purchases and salaries to it to arrive at the operating figures of $297,839.

In Mr Labbe’s opinion, however, the income recorded directly from the receipts and expenditures journal totalled $345,454.82. Additionally, the appellant also calculated his income for 1972 from a document known as a register (Exhibit 1-14) seized in Mr Grenier’s office at Lambert & Grenier Inc, the total sales thus amounting to $375,195.71, including an amount of $289,009 received from Crino, a business owned by the Coopérative Agricole de Granby. The Board allowed the filing of a letter from the Quebec Department of Revenue to the Coopérative Agricole de Granby, in which the appellant’s contract with the Coopérative was mentioned, subject to a later decision during deliberation. The decision was to disallow such a document. Neither the writer of the letter nor the recipient were present to be cross-examined.

The same figure of $375,195.71 was also found in another document which was seized at the residence of Mr Grenier; this journal (Exhibit I-2, and 1-12 as well) was titled “Annual journal and company transfer”. Page 20 contains the entry “Balance sheet for 1972”. At the bottom of this page, it reads:

Contract

The figure of $375,193.70 is found on two other documents seized at the personal residence of Mr Grenier (Exhibit 1-16). One sheet reads “General contract and Crino: $375,193.70” and “Withdrawn from GE: $3,718.70”. The other sheet contains the same two figures, this time added and totalling $378,912.40.

3.16 As Exhibit 1-15, the respondent filed a sales reconciliation based on the amount of $345,454.82. This document reads as follows:

MR JOSEPH B GRENIER

Sales reconciliation at 31/12/72

Proceeds of cash operations, receipts and expenditures

$345,454.82

Adj

3— Unrecorded invoiced

$

16,956.35

Adj

5— Granby

Corp

proceeds

deposited

in

B

of

M

(deposit

cert)

$

25,960.26

Adj

6— Corp cheque not deposited and

used

to

pay

Lambert

and

Grenier Inc re charges for the

company

$

3,643.03

Adj

7— Corp

cheque

not

recorded,

$1,055.09

of

which

was

deposited

in

Bank

of

Com

merce

$

1,755.09

—

8— Sales

entered

in

register (2-e)

for which there are no invoices

$

673.76

—

9— Payment received from Binette

& Frères re Parc des Voltigeurs

and deposited in part in B of M

$

8,295.35

—

10— Cash

payment

received

from

“Roi du Steak”—old account

.

$

8,000.00

—

11— Payment received from “Roi du

Steak”

not

deposited—this

cheque

subsequently

went

to

Lambert & Grenier Inc

$

5,000.00

—

13— Addition

to

accounts

receivable

$

34,690.43

Adj 41—Cheque

received

from

Les

Placements

Mondrum—which

was given to Lambert & Grenier

Inc

$

1,000.00

Adj 43— Cheque

by

Lambert

&

Grenier

Inc deposited in Prov Bank on

5/1/73

$

74.25

$109,048.52

$106,048.52

$451,503.34

Less 24—Cheque

in

trust

re

SOQUAP

delivered and deposited

$

2,000.00

$449,503.34

3.17 The appellant’s accountant questioned the item included in 1-15 and described as “Addition to accounts receivable, $34,690.43”.

Mr Hébert submitted a list of accounts receivable at 31/12/72 (Exhibit A-4). It was allegedly prepared by the respondent’s accountant. This list contains 31 names of debtors owing from $11.50 to $26,040.30. The accounts totalled $113,682.39. On this list, Mr Hébert cited six names (A Beaudoin, R Jacques, M Rousseau, G Provencher, F St-Pierre and SOQUAP Inc), the accounts for whom totalled $12,155.07 and subsequently became bad debts. Another account (Pierre Mandon Inc) of $4,740.32 was subsequently settled for $3,000. Finally, the Hotel Motel Roi du Steak ($26,040.30 and $723.74 = $26,764.04) and the Hotel Motel Quatre Saisons, which owed $14,352.82, were allegedly subsequently settled for lesser amounts. All these amounts, written off or underpaid, totalled $58,012.25. The Board cannot reconcile the sum of $34,690.43 contained in Exhibit 1-15, the amount by which the sales were increased. It should be noted that the Roi du Steak and Quatre Saisons Motel are the property of Les Entreprises Lambert Inc, in which Mr Roger Lambert owned a 49% share.

3.18 As to inventory at 31/12/72, the appellant declared $2,980 and the respondent put it at $6,000.

Mr Labbe stated that this was the appellant’s figure, taken from Exhibit 1-12, p 20, and accepted it as such.

3.19 Current earnings are not shown on the asset side of the balance sheet prepared by the appellant. On the other hand, the sum of $7,088.04 is shown for the same item in the balance sheet prepared by the respondent. Mr Labbe contended that he had established this from documents seized at the taxpayer’s premises.

3.20 According to Mr Labbé, the increase of $9,935.91 in the hotel’s fixed assets came principally from an extension to the building and improvements made to the old hotel bar. The whole amount was treated as having been capitalized.

3.21 The additional difference of $28,700 in the balance sheet item “Other assets” prepared by the respondent consisted of “Certificate of deposit, $25,000”, admitted by the appellant (Exhibit 1-13), and of the item “Mutual funds, $3,766.30”, which Mr Labbé maintained he computed from checked documents. Exhibit 1-13 includes, inter alia, a cheque of $25,960.26 received by Grenier Electrique from the Coopérative Agricole de Granby. This is the amount included in the sales, as appears on the sales reconciliation in paragraph 3.16.

3.22 Mr Hébert emphasized a difference between the “Interest and bank charges”, namely, $2,437.05 in the profit and loss statement prepared by the appellant and $466.37 in the statement prepared by the respondent. However, this amount of $466.37 only applies for the electrical contracting business, while the figure of $2,437.05 applies to that business and the Escale hotel. In the latter’s profit and loss statement, the respondent entered $2,891.87 for this item, which gives ($2,891.87 + $466.37) $3,358.24.

Mr Labbé maintained that he had checked all the documents. That is undoubtedly why this item of expenditure is higher.

3.23 Mr Labbé contended that everything was checked and cross-checked concerning the “Cost of sales” item amounting to $298,766.97 on the profit and loss statement.

3.24 With regard to the “Unexplained withdrawals, $50,092.30” on the capital reconciliation (see paragraph 3.09), Mr Labbé submitted that he Simply could not explain the use of it.

(C) 1973—Denis Lambert and Roger Lambert

3.25 At the start of the hearing a request for an extension of time to appeal was granted to Mr J B Grenier for 1973.

3.26 In his notice of re-assessment the respondent distributed the amount of $22,704.90, which was referred to in Lambert and Grenier Inc (77-282), the case which was heard jointly with the case at bar (see paragraphs 3.17 and 3.24, and 4.3.4 and 4.3.5 of the reasons for judgment rendered in Lambert and Grenier Inc). This amount was paid by Lambert and Grenier Inc to Mr J B Grenier. The latter apparently divided it with the other two shareholders of Lambert and Grenier Inc. The distribution was as follows:

3.27 The respondent based his argument on figures found on a sheet of Exhibit I-2, a photocopy of which also occurs at p 28 of Exhibit 1-1. This page is titled “Withdrawn in 1973”. It indicated dates, abbreviations: GE (Grenier Electrique), LG (Lambert & Grenier Inc), and amounts (20 in all) received. The data on which the respondent relied in basing his assessment are the following:

3.28 The sum of $22,704.90 is thus broken down according to the exhibit by the respondent, and filed at p 27 of Exhibit 1-1:

3.29 As in Lambert & Grenier Inc, heard jointly with the cases at bar, Mr J B Grenier did not testify. His counsel gave the reason that the respondent had brought criminal proceedings against him regarding his taxes and it was preferable for him not to justify.

(D) Penalties

3.30 In its various notice of re-assessment, the Department of National Revenue imposed the following penalties:

Mr J B Grenier

1970: $ 1,160.09

1971: $ 1,008.97

1972: $11,113.09

Mr Denis Lambert

1973: $ 611.26

Mr Roger Lambert

1973: $ 204.72

4. Act—Case Law—Comments

4.1 Act

The principal sections concerned in the cases at bar are 3, 4, subsections 12(2), 46(2), 56(2) and 139(1) of the old Act, and sections 3, 9, subsection 15(1), sections 67, 109, subsections 152(7), 163(2) and subsection 248(1) of the new Act. These sections will be cited below if necessary.

4.2 Case Law

The Board refers to the decisions cited in Lambert & Grenier Inc, heard jointly with the cases at bar.

4.3 Comments

4.3.1 Validity of the 1970 assessment on Mr J B Grenier

Under subsection 152(4) of the new Act, the Minister cannot issue a notice of re-assessment more than 4 years after the date of the earlier assessment, unless he proves (MNR v Maurice Taylor, [1961] CTC 211; 61 DTC 1139), that there was fraud or misrepresentation of the facts through negligence, carelessness or a deliberate omission.

In the case at bar, the evidence showed (paragraph 3.02 of the facts) that the initial notice of assessment was issued on April 4, 1972, and that the following notice, namely the initial notice of re-assessment, was issued on May 23, 1975, and so within the 4 years.

(A) Joseph B Grenier: 1970-71

4.3.2 The appellant’s evidence concerning 1970 and 1971 consisted essentially of explaining that the appellant’s tax return had been filed on the net worth basis, in view of the practically non-existent bookkeeping system. Bearing in mind the burden of proof, this is not a very strong argument, especially as the appellant had been told of this earlier by his accountant. Thus, in his 1972 tax return, the appellant’s accountant included the financial statements for 1969. At the bottom of the “Reconciliation of capital account” statement there is the following note from the accountant, addressed presumably to the Department of National Revenue:

The net income for 1969, amounting to $9,654.19, was determined by reconciliation of net capital as set forth above; the taxpayer took careful note of the recommendations made to him during 1970 regarding an accounting system for his operation.

4.3.3 Moreover, in the notice of objection regarding 1970, 1971 and 1972, the following is stated at paragraph 4:

The taxpayer did not keep a record of all the information regarding his operations, so that it became impossible to determine the total of his income and of his expenses in the manner used by the department to arrive at net income.

The reference in the concluding part of the sentence is specifically to 1972, when the department maintains that its assessment was made using the factual method. The absence of an accounting system is nonetheless confirmed, at least for 1970 and 1971.

4.3.4 The appellant accordingly does not appear to have followed his accountant’s advice. It is clear that, confronted by such an absence of system, an accountant will find it difficult to proceed in any other way than that used by Mr Hébert. However, such negligence does not excuse the appellant or release him from the burden of proof.

The Board has no choice but to affirm the inclusion in the appellant’s income of the amount of $19,928.91 (paragraph 3.05 of the facts) for each of the years 1970 and 1971.

(B) Joseph B Grenier: 1972

4.3.5 Here again, the appellant’s accountant, Mr Hébert, proceeded by the net worth method. He prepared the 1972 tax return and the financial Statements given to him by his client (paragraph 3.06 of the facts). According to Mr Hebert, an accountant in private practice cannot devote as much time to examining documents and undertaking research as investigators at the Department of National Revenue. The Board fully understands that fees would then be exorbitant. There is no question that in order to have good service at a reasonable cost, a businessman should follow the advice of his accountant regarding the keeping of an accounting system, including the filing of supporting documents, all of which makes possible proper recording of information and quick checking.

4.3.6 Following the seizure of 25 boxes of documents (paragraph 3.12 of the facts), the principal witness for the respondent stated that a careful analysis was made and financial statements prepared using the factual method. This was largely demonstrated by the evidence.

4.3.7 In the opinion of the Board, the appellant did not discharge the burden of proof except regarding accounts receivable (see paragraph 4.3.8).

The accountant’s opinion regarding the yield rate is of considerable weight, but it cannot rebut the presumption that the assessment is valid, especially with the evidence presented by the respondent with supporting documents. Indeed, Mr Hébert himself arrived at a net income of over $100,000 (see paragraph 3.11 of the facts) using the factual method. The fact that an excessively high yield rate forced him to return to the net worth method does not necessarily prove that the factual method was wrong, simply that there was a lack of supporting documents of any kind. The respondent’s investigators had the same problem: they uncovered unexplained withdrawals of $50,092.30 in the capital reconciliation (see paragraph 3.09 of the facts). The fact that the respondent’s investigators could not explain the use of these amounts in no way affects the validity of the assessment. The sales total was clearly explained, except once again for the accounts receivable.

4.3.8 After the evidence given by the appellant’s accountant, and described in paragraph 3.17 of the facts, the Board is of the opinion that gross accounts receivable for 1972 amounted to $113,682.39, but that there should be a doubtful claims reserve of $58,012.25 for that year. It is clear that the Act must be applied for the other years, namely that this reserve must be included in income for 1973, provided a new doubtful claims reserve is taken, and so on, until the amount is paid or the account is declared to be a bad debt.

(C) 1973—Denis Lambert and Roger Lambert

4.3.9 In the Board’s opinion the appellants did not discharge the burden of proof resulting from the presumption that the assessment is valid, especially in view of the evidence presented by the respondent’s investigators. This evidence is also contained in the reasons for judgment handed down in Lambert & Grenier Inc.

The facts are clear. Matters were very well arranged by the three shareholders. They put money into their pockets, but not as the result of a bona fide transaction. If that were the case, why would there be so many complications in transferring this money and so many “special” documents to record them?

4.3.10 The only point which seems to be ambiguous is the acquisition by Mr Denis Lambert of an amount equal to that of Mr Grenier ($9,554.81), when Mr Lambert owned only 25% of the shares and Mr Grenier 50% of the shares of Lambert & Grenier Inc. To begin with, the Board is not obliged to explain this fact. The evidence is clear enough by itself for the appeal to be dismissed. However, one explanation that seems plausible is the fact that Mr Denis Lambert is the company’s manager, and perhaps as such it was agreed to give him special consideration.

(D) Penalty

4.3.11 In Joseph B Grenier, the penalties are upheld for 1970, 1971 and 1972, both on account of the gross negligence with which the books were kept, which forced the accountant to use the net worth method (not the best one), and so to omit income, and because of the substantial amounts in question, despite the fact that the appeal was allowed in part for 1970 [s/c], with respect to accounts receivable.

4.3.12 The penalty is also upheld as to Denis Lambert and Roger Lambert, because of the fraudulent means used to get hold of the company’s funds. They cannot plead ignorance. It is logical to assume that by not including the amount received in their income, the appellants simply continued to act in the same spirit as that of the method used to acquire the said amount.

5. Conclusion

The appeals are allowed in part and the matter is referred back to the respondent for re-assessment in accordance with the foregoing reasons for judgment.

Appeal allowed in part.