Joseph De Smet v. Minister of National Revenue, [1977] CTC 2342, 77 DTC 231

Guy Tremblay [TRANSLATION]:—This case was heard in Montreal on January 18, 1977.

1. Summary

The Board must decide whether the assessment of $7,500 by the respondent in accordance with the net worth method, in respect of the years 1970 to 1973, is justified. It must also decide whether the penalty of 25% assessed by the respondent is justified.

2. Burden of Proof

On the one hand the burden of establishing that the assessments by the respondent are not justified is on the appellant. 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 Johnston v MNR, [1948] CTC 195; 3 DTC 1182.

On the other hand, the burden of establishing, under subsection 163(3) of the new Act, that the penalties of 50% and 25% assessed under subsections 163(1) and (2) of the new Act should be upheld, rests on the respondent.

3. Proven Facts

3.1. In 1965 and subsequent years, the appellant invested heavily, in terms of both time and money, in a mink farming operation.

3.2. These investments were made through the Société De Smet et Frères. The appellant and his two brothers, Oscar and Roger, purchased a farm at St-Jude in the Province of Quebec, and installed the necessary equipment to carry on mink farming Operations. By the appellant’s own testimony, his wife contributed her share of the money. From January 1966 to August 1968 she allegedly used her own salary to buy a small pick-up truck for the company.

3.3. In early 1971 the appellant sold his shares in the company for $1, so that he could devote all his attention to a cannery he owned in St-Jude.

3.4. In early 1975 the respondent conducted an investigation into the income of both the appellant and the Société De Smet et Frères.

3.5. According to Mr Denis Corbeil, inquiries officer representing the respondent, neither the company, nor the appellant personally, had a bookkeeping system or kept supporting documents. For this reason he used the net worth method with a capital reconciliation between December 31, 1969 and December 31, 1973. As shown in the capital reconciliation attached to the tax return for 1973, there was a difference of $10,553.53. According to Mr Corbeil, these balance sheets were later accepted by the shareholders of the company.

3.6. The company’s balance sheet for the years 1967 to 1973, drawn up by the respondent’s representative on the basis of information Supplied by the De Smet brothers, and with their co-operation, was entered as evidence.

3.7. The balance sheet for the period ending December 31, 1971 showed that the company owed appellant the amount of $5,000. On the balance sheet for the period ending December 31, 1971 the amount of $7,500 is recorded under the same heading.

3.8. In addition, Mr Corbeil submitted Exhibit 1-2, an acknowledgment of indebtedness for the $7,500, which read as follows:

(TRANSLATION)

St Jude, February 3, 1975

De Smet and Bros acknowledge their debt of $7,500 to Joseph De Smet for money lent in 1971 and 1972:

1971 — $5,000:

1972 — $2,500.

To date, no part of this amount has been repaid.

Joseph De Smet

(Sgd) De Smet Joseph De Smet et frères

(Sgd) De Smet Oscar Oscar De Smet

(Sgd) Roger De Smet Roger De Smet

3.9. This handwritten acknowledgment of indebtedness was not drawn up by the representative of the Department. Apparently, it was the work of the accountant of the Société De Smet et Frères. The document was given to Mr Corbeil by the De Smet brothers.

3.10. In the inquiry, the appellant insisted that the only points he wished to make were, on the one hand, the lack of justification for including this $7,500 in his income, and on the other hand, his good faith in the matter.

3.11. While admitting to having signed the document, he maintained that he did not fully understand its meaning and was not aware that 1972 was included. He maintained that he could not possibly have lent $7,500 during 1971 and 1972 because, in his own words, “those were lean years”. The $7,500 was money that he and his wife allegedly had been paying into the company from the time it was established until early 1971, when they sold their shares in the company.

3.12. On May 29, 1975 the respondent issued a reassessment for 1970, 1971, 1972 and 1973, adding the amount of $2,638.38 to the income for each of these years. The penalty of 25% provided under subsection 163(2) of the new Income Tax Act was also assessed in respect of each of these years. The amounts for 1970, 1971, 1972 and 1973 were $245.88, $238.96, $111.48, and $118.48 respectively.

3.13. On July 17, 1975 the appellant objected to the assessment for 1970 through 1973.

3.14. On February 27, 1976 the respondent advised the objector that it was confirming the assessment for the years in question.

3.15. On May 1, 1976 the objector appealed to this Board.

4. Points at Issue

Has the appellant discharged the burden of proof which lies on him—that of showing that the inclusion of the amount of $7,500 in his income was unjustified?

Has the respondent discharged the burden of proof which lies on him—that of showing that he was justified in upholding the penalties of 50% and 25% respectively, under subsections 163(1) and (2)?

5. Comments

On the basis of evidence adduced by the respondent, the inclusion of the amount of $7,500 appears to be quite justified, in light of the balance sheet of the Société De Smet et Frères and the acknowledgment of indebtedness signed by the appellant, among others. It does seem strange that the company’s acknowledgment of indebtedness, dated February 3, 1975, should have been signed by the appellant, since at that time he had ceased to be a shareholder in the company for over four years. At the very least, this document shows that the appellant, for his own part, understood the general meaning of the document—which was that he lent the company $5,000 in 1971 and $2,500 in 1972.

With respect to this matter, the appellant maintains that he did not completely understand the general meaning of the acknowledgment of indebtedness, especially in the case of the 1972 year. Furthermore, he insists that the said amount represents his and his wife’s investment in the company ever since its establishment early in 1971. The Board wonders whether this $7,500 represents the real price of the sale of company shares, although their official price is $1. The Board would tend to think so. Nevertheless, the burden of proof rests squarely on the appellant’s shoulders. The Board finds it difficult to reject the written acknowledgment of this debt, which was further confirmed by the company’s balance sheet, solely on the basis of one man’s testimony. The evidence shows that the shareholders have attested to this.

The Board accordingly upholds the assessment with respect to the capital payable and interest. If the appellant is right, in the first place he should not have signed the papers with so little forethought; in the second place, he should have prepared his case accordingly. In the inquiry no one represented him and he handled his case alone. At any rate the Board thought he knew that he was not represented by a lawyer.

Imagine the Board’s surprise when the appellant stated near the end of the inquiry that he had just realized that Mr Guy Dupont was not his own lawyer. Mr Guy Dupont and Miss Louise Belair represented the respondent in this case. Toward the close of the inquiry, Mr Dupont raised stronger arguments against the appellant. “When he started attacking me,’’ said the appellant, “I realized he wasn't my lawyer.’’

It is sometimes astonishing to discover in court the extent to which some taxpayers can be mixed up in a situation, while still acting, or appearing to act, in good faith. The Board is inclined to believe that in the appellant’s case this confusion is also reflected in the organization of his financial affairs, at least with respect to both the years involved in this case and previous ones.

The appellant was not able to discharge the burden of proof in so far as the assessments on his capital and interest were concerned. The Board must also conclude that the respondent, for his part, did not discharge the burden of proof with respect to the penalty under subsection 163(1) of the new Act.

With respect to the penalty of 50% under subsection 163(1), the respondent had to prove that the appellant wilfully attempted to evade payment of the tax payable by him by failing to file a return of income for 1972 and 1973. The respondent did not prove this.

With respect to the penalty of 25% under subsection 163(2) of the Act, the respondent had to prove that the appellant “knowingly, or under circumstances amounting to gross negligence . . . made . . . a statement or omission in a return . . .’’.

No evidence has been adduced to show any dishonest intention to cheat the income tax authorities.

Has it been proved that there were “circumstances amounting to gross negligence’’?

Is the statement of the auditor for the respondent that the appellant, and the company of which he was a shareholder, had no bookkeeping system and kept no supporting documents, sufficient proof?

The Board and the courts have often based their decision to uphold the penalty of 25% on this fact.

Are there any extenuating circumstances to justify the Board’s treating this case differently?

The fact that the mink farm is now a flourishing family business because of the time and money invested jointly in it between 1965 and 1971, be it on the part of the three De Smet brothers or of the appellant’s wife, unquestionably speaks well for these persons; but can this highly laudable mutual effort now justify the total absence of an accounting system, when the total cost of assets for the firm was $20,683.02 in 1967, $54,282.76 in 1970 and $105,303.94 in 1973, according to the balance sheets? Is there any business—and a mink farm certainly qualifies as that—or any person with so little judgment that he would plunge into a business without giving any thought to bookkeeping or to preserving supporting documents, especially when he has to know at year-end whether the business has made a profit or lost money? These are all considerations whether one works to earn a living or simply for the sheer pleasure of working.

In his testimony, the appellant certainly did not appear to be a stupid person, even if he sometimes did seem a little confused. Furthermore, the appellant owns another firm—a cannery—and carries on business in the form of a company.

Is it not true that he gave up his share in his relatives’ company in 1971 so that he could devote himself to his cannery? Is this not an indication of his initiative? Does this not show that he is a shrewd businessman?

If the answer to these questions is “yes”, then the appellant showed bad faith in carrying on these businesses without using an accounting system.

If the answer to these questions is “no”, then the appellant showed crass ignorance and the “gross negligence” described in subsection 163(2) in acting in such a hit-and-miss fashion.

By requiring businessmen to keep books, the Income Tax Act probably prevents as many bankruptcies in business as actually do occur each year.

The Board accordingly upholds the penalty of 25% under subsection 56(2) of the former Income Tax Act for the 1970 and 1971 taxation years, and under subsection 163(2) of the new Act for the 1972 and 1973 taxation years.

Finally, the Board upholds another penalty assessed by the Minister for the 1972 and 1973 years—the penalty of 5% for late filing under section 162 of the new Act.

6. Conclusion

For the aforementioned reasons, the Board upholds the assessments in respect of capital and interest and in respect of the penalty of 25% for the 1970, 1971, 1972 and 1973 years. The Board also upholds the penalty of 5% for the 1972 and 1973 years. Moreover, it rejects the assessment in respect of the penalty of 50% for the 1972 and 1973 years.

Appeal allowed in part.