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Citation: 2003TCC433
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Date: 20030626
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Docket: 1999-2485(IT)G
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BETWEEN:
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HENRY BERNICK,
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Appellant,
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and
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HER MAJESTY THE QUEEN,
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Respondent.
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REASONS FOR JUDGMENT
Miller J.
[1] During
1992, 1993 and 1994, the Appellant, Mr. Henry Bernick, was a partner in a
Bahamian partnership known as The Group of Eighteen (the
"Partnership"). The Partnership owned certain securities, being a
British Gas Zero Coupon Bond with a maturity value of US$7.5 million (the
"UK Bond") and several Japanese Marine and Fire Insurance Convertible
Bonds with a maturity value of $147 million yen (the "Fire Marine
Bonds"). The Partnership disposed of the UK Bond and Fire Marine Bonds
over the three years in question, and claimed losses of US$2,280,318,
US$2,336,385 and US$1,710,165 in 1992, 1993 and 1994, respectively. These
losses were based on an initial cost calculated on the basis of the maturity
value of the UK Bond and Fire Marine Bonds (collectively the
"Bonds"), a position Mr. Bernick claims is supported by Bahamian
generally accepted accounting principles (GAAP). The Respondent denied the
Appellant's 90 per cent share of such losses, and assessed on the basis there
were net gains, not losses, relying on the initial cost of the Bonds being
their market value, not their maturity value, a position the Respondent claims
is supported by Canadian GAAP and international accounting standards.
[2] The
issues are:
1. What is the proper determination
of Mr. Bernick's income in 1993 and 1994 for Canadian tax purposes?
The method relied upon by Mr. Bernick
does not present an accurate picture of his income and the proper determination
is as assessed by the Respondent.
2. Has the Respondent proven that
Mr. Bernick knowingly or under circumstances amounting to gross negligence made
false statements or omissions in his 1992, 1993 and 1994 returns, justifying
the imposition of penalties pursuant to subsection 163(2) of the Act?
The Respondent has proven that
Mr. Bernick knowingly acquiesced in the making of an omission in the financial
statements filed with Mr. Bernick's 1992, 1993 and 1994 returns, though any
understatement of income was not attributable to the omission, but attributable
to the principles relied upon by Mr. Bernick. Therefore, the penalty pursuant
to subsection 163(2) of the Act is limited to $100 in each of 1992, 1993
and 1994.
Facts
[3] During
the late 1970s and early 1980s, Mr. Bernick, as a result of a long‑standing
relationship with Wood Gundy, London, United Kingdom, was led to investigate
the Japanese financial markets. His lengthy and thorough investigation resulted
in a decision to invest, not in individual Japanese companies but in the fire
and marine insurance companies who are major shareholders in individual
Japanese companies, such as Toyota. Mr. Bernick was most successful in this
investment strategy and clearly showed a comprehensive understanding of that
market. In the mid-1980s, Mr. Bernick was also very involved in land
development in Barrie, Ontario. His companies held a one-third interest in one
real estate limited partnership and a one-quarter interest in another real
estate limited partnership. He was personally engaged to manage these real
estate businesses. By the early 1990s, Mr. Bernick realized these real estate
enterprises would yield significant income in the upcoming few years.
[4] In
July 1992, Mr. Bernick's lawyer of longstanding, Mr. John McKellar of Weir
& Foulds, suggested to Mr. Bernick that he talk to Mr. E.P. Toothe, a
Bahamian lawyer who had an investment in which Mr. Bernick might be interested.
Mr. Bernick followed up and contacted Mr. Toothe in July 1992. He
determined that the investment consisted of several Japanese fire and marine
insurance convertible bonds, an investment in which he was intimately familiar,
along with a UK British Gas Zero Coupon Bond. Mr. Bernick asked for particulars
and received a listing of the Bonds. He was also made aware that the investment
would be by way of purchase of units in a Bahamian partnership, which would be
the owner of the Bonds. Mr. Bernick analyzed the Bonds and came up with the
following values:
Schedule "A" List of
Securities
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No. of Bonds
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Denomination
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Name
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Maturity
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¥
Million
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U.S$ Million
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US$ Value determined by Bernick
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1
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¥ Million
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Tokio Marine & Fire Insurance
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CV1
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31/03/97
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1
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59
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"
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Mitsui Marine & Fire
Insurance
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CV1
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29/03/02
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59
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54
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"
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Sumitomo Marine & Fire
Insurance
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CV2
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31/03/03
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54
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20
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"
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Nippon Fire & Marine
Insurance
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CV2
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31/03/98
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20
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13
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"
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Yasuda Fire & Marine
Insurance
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CV2
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31/03/98
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13
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147
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147
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1,000,050
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750
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U.S.$ 10000
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British Gas International Finance
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Zero
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4/11/21
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7.5
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750,000
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[5] In
effect, Mr. Bernick valued the Partnership units, being 1,800 in total, at
US$1.8 million or US$1,000 per unit. He requested, and received, a copy of the
Partnership Agreement. Throughout August Mr. Bernick proceeded to arrange with
friends, family and associates to put up the US$1.8 million to acquire 1,798 of
the 1,800 Partnership units. Mr. Toothe, as managing partner, owned two of
those units. He acquired a further 16 units to give himself a one per cent
interest. The units were to be bought from P.T. Limited, a Bahamian
corporation. Mr. Bernick was acquiring 1,620 and the rest of the group
were acquiring 178 units. Mr. Bernick flew to Nassau on September 2, 1992
with cheques from the others in hand to close the transaction on
September 3. Mr. Bernick's cheque for $1.62 million was dated September 2.
[6] Meanwhile,
in Nassau, matters were likewise moving ahead. The Partnership Agreement was
entered into on August 10, 1992, between Mr. Toothe and one of his
associates, Mr. Barry Sawyer. The Agreement was registered with the Registrar
General for the Bahamas on August 21. That same day, P.T. Limited agreed to
transfer the Bonds into the Partnership in exchange for 1,798 Partnership
units, such transaction to close on September 3, coincidentally with the sale
of the 1,798 Partnership units of P.T. Limited to Mr. Bernick and his
group. The exchange agreement between P.T. Limited and the Partnership reads in
full as follows:
Whereas the Vendor agrees to Sell
and the Purchaser agrees to Purchase the Securities listed in Schedule 'A'
attached hereto.
The Vendor and Purchaser agree that
the consideration for the Sale and Purchase of said Securities listed in
Schedule 'A' shall be:
The Issue by Purchaser to Vendor of
1,798 Partnership Units of the Partnership "The Group of
Eighteen"
The Transaction shall be completed
on or before the 3 day of Sept. 1992 at the Offices of E.P.
Toothe & Associates, 3rd Floor Maritime House, Frederick Street, City of
Nassau.
[7] The
list of the bonds attached to the Agreement is the list that had been
previously sent to Mr. Bernick for review. The UK Bond had a value at this
point of $9.34 per $100 face value, or $700,500. Mr. Bernick realized that the
UK Bond yielded a less attractive return than the Fire Marine Bonds. It was his
view from the outset that it would be desirable for the Partnership to dispose
of the UK Bond over time and acquire bonds similar to the Fire Marine Bonds.
So, soon after Mr. Bernick and his group's acquisition, the Partnership
disposed of a portion of the UK Bond with a maturity value of US$2.5 million.
Again in January 1993, the Partnership disposed of an additional segment of the
UK Bond with a face value of US$2.5 million. Both these sales were at values of
just under ten cents on the dollar – ten cents being Mr. Bernick's
estimate of the value for purposes of making the $1.8 million offer for the
Partnership units. Later in 1993, the value of the UK Bond got up over fourteen
cents on the dollar and the Partnership disposed of another segment with a face
value of US$500,000. Finally, in January 1994 the Partnership disposed of the
final US$2 million, then at a value of approximately twelve cents on the
dollar.
[8] Mr.
Bernick, who served as the Partnership's sole investment advisor, did not
suggest selling all of the UK Bond in 1992. He said it was simply a business
decision to sell in part.
[9] The
Partnership produced a balance sheet as at September 4, 1992 which reads as
follows:
The Group of Eighteen
A Partnership organized Under the
Partnership Laws of
the Commonwealth of the Bahamas
BALANCE SHEET
(U.S. $)
September 4, 1992
ASSETS
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U.S. $
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Cash
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2,000
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Securities (Note
A)
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147 Million ¥ C.V. Bonds (125¥/$)
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1,176,000
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7,500,000 U.S. $
British Gas Zero Bonds
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7,500,000
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8,676,000
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8,678,000
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LIABILITIES
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1,800 Partnership
Units
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8,678,000
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[10] Both the Fire Marine Bonds and UK Bond were recorded at maturity
value. The Partnership's December 31, 1992 year end balance sheet indicated the
inventory of trading securities at a cost of US$6,394,107 (this takes into
account the disposition of part of the UK Bond with a face value of
US$2.5 million), but also had a line stating, "Market value of
securities – $1,879,560". There was no indication the cost was based on
maturity value. The 1993 and 1994 financial statements were similar in that
regard.
[11] Mr. Bernick indicated that he received the 1992 financial statements
in February 1993 and was delighted to see his $1.8 million investment had grown
to $1,879,560. He expressed no surprise and little interest in the recording of
the Bonds at maturity value. He maintained it was only at this point he was
aware that, because of recording cost at maturity value, the disposition of the
UK Bond yielded a significant loss. Attached to the financial statements was a
statement of 1992 income tax information, which spelled out Mr. Bernick's
C$2,468,903 loss. He referred to this as a book loss. These financial
statements were prepared by Mr. Graeme H.E. Jones, a Toronto chartered
accountant. Mr. Jones' auditor's Report for those statements, which are similar
for all three years at issue, reads in part as follows:
... These financial statements are the responsibility
of the partnership's management. My responsibility is to express an opinion on
these financial statements based on my audit.
I conducted my audit in accordance with generally
accepted auditing standards. Those standards require that I plan and perform an
audit to obtain reasonable assurance whether the financial statements are free
of material misstatement. ...
In my opinion, these financial statements present
fairly, in all material respects, the financial position of the partnership as
at 31 December, 1992 and the results of its operations and the changes in its
financial position for the period then ended in accordance with generally
accepted accounting principles.
[12] The advice Mr. Bernick received from his law firm, Weir & Foulds
and from Mr. Jones, was that this loss could be offset by the significant gains
he was realizing in his real estate business in Canada, and that tax could then
be postponed until his or his wife's death. This, he was advised, was as a
result of the cost of his Partnership units going into a negative position,
which would trigger a tax liability on death. Mr. Bernick inquired as to the
magnitude of such a liability, and upon being advised that it was approximately
C$5,000,000, he proceeded to take out a life insurance policy for that amount.
He has paid premiums in excess of US$700,000 to date on that policy, and still
maintains the policy to cover this future liability.
[13] In filing his 1992, 1993 and 1994 returns, Mr. Bernick attached copies
of the Partnership Financial Statements prepared by Mr. Jones, including the
statements of his loss position for tax purposes. Mr. Bernick, also on advice
of Price Waterhouse, flowed business income in his companies in 1992, 1993 and
1994 of $2,382,000, $2,695,000 and $2,108,000 into his hands personally as
management fees. No fees were paid to Mr. Bernick in 1995, 1996 and 1997,
though in 1998, 1999 and 2000 there were again fees of $150,000, $350,000 and
$900,000, respectively. In 2000, Mr. Bernick recorded Partnership losses of
$870,527 arising from the disposition of certain Ontario Zero Coupon Bonds
which the Partnership had acquired in an exchange with a company called
Sycamore Investments in 1994. Sycamore, similar to P.T. Limited, had
transferred into the Partnership some fire and marine convertible bonds and the
Ontario Zero Coupon Bond in exchange for Partnership units. Mr. Bernick and his
group then acquired the Partnership units. Mr. Bernick acknowledged that any
bonds acquired on an exchange like that were recorded at maturity value, while
any securities acquired by the Partnership in the market itself were recorded
at market value. He believed there was a distinction.
[14] Before turning to the experts' evidence, there are some provisions in
the Partnership Agreement which should be mentioned. It provided as follows:
... Solely for the purposes of
determining profits, losses, distributions and returns of capital, the
aforesaid financial statements, except for manifest material error, shall be
conclusive.
...
The partnership
business shall be conducted and managed solely by the Managing Partner subject
to the control of any resolution or decision of the partners ... .
... Notwithstanding anything in
this agreement contained, no partner owing [sic] more than fifty per cent of
the outstanding units shall be entitled to a greater vote than fifty per centum
of the votes attaching to the units then outstanding. ...
[15] Within one year of investing in the Partnership, all partners, other
than Mr. Bernick, had received a return of their capital. Mr. Bernick was to
get his return in cash and in kind over time.
[16] Each Party presented an accounting expert's report. The Appellant
presented a report of Mr. Dayrrl R. Butler, a chartered accountant duly
licensed in both the Bahamas and Canada. He has practiced in Nassau since 1984
with Butler & Taylor, a member firm of Moore Stephens International
Limited. His opinion, succinctly, was that it was proper and acceptable for a
Bahamian partnership to record in financial statements in 1992, 1993 and 1994
the value of its investment in long-term marketable securities at their
maturity or face value. Mr. Butler divided his opinion between the period 1992
and earlier and the post‑1992 period, as it was not until 1993 that the
Bahamian Institute of Chartered Accountants specifically defined generally
accepted standards, or what we would call in Canada generally accepted
accounting principles (GAAP). Until 1993, in the Bahamas, GAAP was simply the
choice of the chartered accountant preparing the accounts, evaluated by the chartered
accountant based on his or her experiences. The chartered accountant took into
account what may be appropriate for disclosure to banks, trusts and insurance
companies. The chartered accountant also would fall back on the GAAP of his or
her mother country being normally either the United States, United Kingdom or
Canada. According to Mr. Butler, accounting for securities in 1992 would be at
cost, fair market value or the managing partner's valuation, provided it is
fair and not misleading to intended users. Normally, in a partnership, the only
users would be the partners themselves. Mr. Butler indicated it was a practice
in the Bahamas for an auditor not to inquire of the managing partner, from whom
instructions would be taken, as to the makeup of the partnership, that is, who
were the partners.
[17] Accounting for the securities after 1992 would be subject to Rule
7 of the Bahamian Institute of Chartered Accountant Regulations wherein
applicable accounting standards are:
1. IAS,
promulgated by the International Accounting Standards Committee (IASC), except
for any IAS that are specifically excluded by BICA;
2. accounting
standards that differ from IASC standards, if there is substantial support for
alternative treatment and disclosure is made;
3. accounting
standards that are generally accepted for ordinary industrial and commercial
enterprises; and
4. accounting standards
required by any written law;
5. provided,
however, that where there is a conflict between any of the various accounting
standards, the Chartered Accountant must ensure that appropriate disclosure is
made in the financial statements and that his report is appropriately modified.
[18] Mr. Butler went so far as to suggest that because the Partnership's
financial statements referred to market value, that they would also be in
accordance with Canadian GAAP or international accounting standards.
Mr. Butler was not presented as an expert on other than Bahamian GAAP, and
it was clear from his testimony that his knowledge of Canadian GAAP was
outdated, though would have been current in the 1980s. While the Respondent
raised no objection to his qualifications as an expert on Bahamian GAAP, his
credentials were not much more than simply being a chartered accountant in the
Bahamas. This goes to the weight to attribute to his testimony. The overall
impression he left concerning Bahamian GAAP, as applicable to partnerships, was
that prior to 1993 it was a managing partner's call as to how to account for
acquisitions. Then, after 1992, with some guidelines in place, Mr. Butler
suggested the principle of consistency should dominate, justifying continuing
to account in the same way as before 1993.
[19] When asked how he would explain the significant losses shown on the
financial statements to an inquiring partner, his response was that it would be
inappropriate to talk to the partners, as he could only talk to the managing
partner. This type of answer, combined with Mr. Butler's limited credentials,
weakened the value of his testimony.
[20] The Respondent presented the report of Mr. Daniel B. Thornton, PhD,
FCA, Professor of Financial Accounting and Distinguished Faculty Fellow at the
School of Business, Queen's University, Kingston, Ontario. His credentials were
exhaustive and impressive, and I accept his testimony as to GAAP without
reservation. He has, however, not practiced for 30 years as an active chartered
accountant: he is an academic.
[21] Professor Thornton's opinion was that under GAAP, the cost of the
Bonds is equal to their fair value on the date acquired. The fair value of
bonds is obtained by discounting the maturity value at a rate of interest
implicit in the prices of similar bonds, in this case about 8.25 per cent. The
fair value on that basis would be $700,500 for the UK Bond. Subsequent carrying
values might differ depending on whether Canadian or international GAAP on the
one hand, or United States GAAP on the other, is relied upon. Professor
Thornton's conclusion was that recording the Bonds at face or maturity value
was not an acceptable accounting practice under any circumstances. He further
indicated that in the early 1990s Canadian GAAP and international accounting
standards were very similar. He cited specific principles of Canadian GAAP from
The Canadian Institute of Chartered Accountants Handbook, which confirmed the
appropriate recording of non-monetary exchanges, such as the P.T. Limited
transfer of the bonds into the Partnership for Partnership units, should be at
fair value. He also confirmed that every well-developed set of GAAP would have
a similar framework.
[22] Professor Thornton did not profess to be an expert on Bahamian GAAP,
nor to be an active practicing accountant. However, he was incredulous that any
system would accept as appropriate a managing partner setting whatever amount
he wanted to as the cost in a non-monetary exchange. It simply was not
reasonable in his opinion.
[23] An example put forward by the Appellant's counsel, Mr. Wortzman, of
KPMG statements reflecting bonds at maturity was discounted by Professor Thornton
as attempting to compare apples to oranges, as the bonds KPMG was accounting
for were fixed interest bonds, for which maturity and value would not be that
far apart.
[24] Professor Thornton stressed the underlying principle for any GAAP system
was representational faithfulness. Recording securities at maturity of ten
times their value, and reporting losses on such basis, could in no way be
viewed as representatively faithful. Though Professor Thornton did acknowledge
on cross-examination that GAAP is ever changing and is in constant evolution,
with an ultimate goal of world-wide consistency, he did not go so far as to
accept Mr. Butler's description of Bahamian GAAP in the early 1990s.
[25] Finally, Mr. J. Nalevka, the Canada Customs and Revenue Agency (CCRA)
audit team leader of Mr. Bernick's audit and of Mr. Bernick's companies' audits
gave evidence. While he shed some light on the process, and some of the reasons
for proceeding with a penalty assessment, his testimony added little factual
background for deciding this case.
Appellant's Argument
[26] While it is not always necessary or desirable to attempt to summarize
both sides' arguments, in this case it is appropriate given the meticulous
manner in which Mr. Wortzman unfolded his argument, as an engineer might
construct a building, one block at a time. The finish product, unfortunately
for Mr. Bernick, has a structural flaw.
[27] Mr. Wortzman commenced by casting aside any notion that the principle
of determining costs at the lower of cost or market constituted a rule of law
back in the early 1990s. He relied on the introduction of subsection 96(8) of
the Income Tax Act, effective after December 21, 1992 in support of this
contention. Subsection 96(8) mandated the lower of cost or market in connection
with a Canadian resident partner becoming a member of a foreign partnership.
So, argues Mr. Wortzman, prior to that time such a principle was not the law.
[28] He then took me to the Friedberg v. Canada case, of which he
was intimately familiar, for the proposition that where there are two
acceptable accounting treatments, the courts need not accept the accounting
system which most accurately reflects the economical reality. Thus, in a case
where a taxpayer deliberately plans to defer income, the taxpayer could rely on
the lower of cost or market, and was not required, as the Crown contended in
that case, to use the mark-to-market method, notwithstanding it was more
accurate. Mr. Wortzman went on to limit the Supreme Court of Canada's analysis
in Canderel Limited v. The Queen,
on this point, to the context of only dealing with the matching principle.
[29] The next block put in place by Mr. Wortzman was the Duke of
Westminister block or in Canadian terms, the Neuman block. It is still acceptable
for a taxpayer to take advantage of tax-planning schemes to minimize taxes. A
taxpayer can arrange affairs to defer income. And this was all that
Mr. Bernick did. It is clear that he took out life insurance to cover the
inevitable tax he was advised he would face on death. He relied on accounting
principles to defer income, principles he believed were acceptable and not
contrary to any legal principles.
[30] The acceptability of the principle of recording the UK Bond at
maturity was confirmed by the Appellant's expert, Mr. Butler. The contention by
the Respondent's expert, Professor Thornton, that the financial statements did
not accord to representational faithfulness, as they did not honour the
economic substance, while perhaps a classic academic definition, ignored the
practical application certainly as enforced in the Bahamas in the early 1990s.
[31] Finally, on the main issue, Mr. Wortzman laid in place the block,
drawn from the Shell Canada Limited v. The Queen case, that the
economic effects of a transaction cannot re-characterize a legal relationship.
He recognized though that the issue here is not one of a legal relationship,
but of an accounting determination, so relied on Shell by way of analogy
only.
[32] With respect to penalties, Mr. Wortzman identified four factors which
he contended led CCRA, specifically Mr. Ken Parsons, auditor, to recommend
penalties:
1. Materiality;
2. Difficulty in getting books and records;
3. Age; and
4. An obscured filing.
[33] The elements of materiality were the discrepancy between fair value to
maturity value (10 times) and Mr. Bernick's sophisticated business acumen.
While the former is a fact, the latter does not imply a detailed understanding
of either financial statements or tax matters. Mr. Wortzman confirmed age was
not and should not be a factor. With respect to CCRA's difficulty in getting
books and records, this arose due to the offshore nature of the investments,
not any lack of cooperation on Mr. Bernick's part. This was not a matter of destroying
documents or leading CCRA astray. Mr. Bernick sought advice as to how to deal
with requests and acted accordingly.
[34] On the factor of obscuring information, Mr. Wortzman made the point
that Mr. Bernick was never advised by CCRA that this was a concern. Mr. Bernick
provided audited financial statements, he showed he was earning business income
and that he was not hiding anything. If Mr. Bernick believed he was taking
proper steps to defer tax, he should not be penalized for it.
Respondent's Argument
[35] The Respondent's position was straightforward. The Partnership was
involved in a trading operation. Even the Appellant's expert acknowledged that
if the securities were short term on trading account, recording costs at fair
market value should have been used. There is just no principle, whether
Canadian GAAP, international accounting standards or Bahamian GAAP, or basic
business principles that the Partnership's trading investment could or should
be recorded at maturity. Presenting on that basis does not fairly present the
Appellant's true income position.
[36] The Respondent disagrees with the Appellant's characterization of Canderel
as limited in any way. Canderel provides a clear recommended approach by
the Supreme Court of Canada to the determination of income, and in following
that approach there is no confusion – in law the UK Bond cannot be recorded at
maturity value.
[37] With respect to penalties, the Respondent says that Mr. Bernick knew
he was asking CCRA to rely on financial statements he knew not to be true. The
suggestion that Mr. Bernick was engaged in a legitimate tax deferral
arrangement does not ring true, as the income giving rise to tax on Mr.
Bernick's death would be on capital account (negative adjusted cost base of partnership
interest) and not on income account, as were the purported losses triggered on
the disposition of the UK Bond. Mr. Bernick knowingly or in circumstances
amounting to gross negligence, made false statements to CCRA.
Analysis
[38] Notwithstanding Mr. Wortzman's attempt to limit the import of the
Supreme Court of Canada's decision in Canderel, I view that case as authority for the
principles governing the computation of income which Justice Iacobucci set out
as follows:
(1) The determination of
profit is a question of law.
(2) The profit of
a business for a taxation year is to be determined by setting against the
revenues from the business for that year the expenses incurred in earning said
income: M.N.R. v. Irwin, supra, Associated Investors, supra.
(3) In seeking to
ascertain profit, the goal is to obtain an accurate picture of the taxpayer's
profit for the given year.
(4) In
ascertaining profit, the taxpayer is free to adopt any method which is not
inconsistent with
(a) the
provisions of the Income Tax Act;
(b) established
case law principles or "rules of law"; and
(c) well-accepted
business principles.
(5) Well-accepted
business principles, which include but are not limited to the formal
codification found in G.A.A.P., are not rules of law but interpretive aids. To
the extent that they may influence the calculation of income, they will do so
only on a case-by-case basis, depending on the facts of the taxpayer's
financial situation.
(6) On
reassessment, once the taxpayer has shown that he has provided an accurate
picture of income for the year, which is consistent with the Act, the
case law, and well-accepted business principles, the onus shifts to the
Minister to show either that the figure provided does not represent an
accurate picture, or that another method of computation would provide a more
accurate picture.
[39] The road map starts at Justice Iacobucci's third principle. Does the
system relied upon by Mr. Bernick yield an accurate picture of his profit? If
so, then move to the next question of determining whether such method is
inconsistent with the Act, rules of law or well-accepted business
principles. If no inconsistency, then ask if the Minister of National Revenue
(the Minister) can prove there is another method providing a more accurate
picture.
[40] While it would be easy to make this case more complicated than it
really is, and delve at great length into the interplay between GAAP, rules of
law and well-accepted business principles, the answer to the first question is
so resoundingly no that little more analysis is required. Recording the UK Bond
at maturity value, whether a principle of Bahamian GAAP or a well-accepted
business principle, does not in any way lead to an accurate portrayal of
Mr. Bernick's income. The law in 1992 was best expounded by Justice
Thorson comments in M.N.R. v. Publishers Guild of Canada Limited
(No. 90 v. M.N.R.)
where he stated:
... I cannot express too strongly
the opinion of this Court that, in the absence of statutory provision to the
contrary, the validity of any particular system of accounting does not depend
on whether the Department of National Revenue permits or refuses its use. What
the Court is concerned with is the ascertainment of the taxpayer's income tax
liability. Thus the prime consideration, where there is a dispute about a
system of accounting, is, in the first place, whether it is appropriate to the
business to which it is applied and tells the truth about the taxpayer's income
position and, if that condition is satisfied, whether there is any prohibition
in the governing income tax law against its use. If the law does not prohibit
the use of a particular system of accounting then the opinion of accountancy
experts that it is an accepted system and is appropriate to the taxpayer's business
and most nearly accurately reflects his income position should prevail with the
Court if the reasons for the opinion commend themselves to it.
This approach appears to have been reaffirmed in the West Kootenay
Power and Light Company Limited v. The Queen
decision and again set in stone in Canderel. They all require that, as
the basic starting point there must be an accurate reflection of income; that
is, tells the truth about the taxpayer's income. Mr. Wortzman suggests that the
Friedberg case provides support for the proposition that the system
relied upon need not result in the most accurate picture. Friedberg, I
suggest, in this regard is out of sync with the law that went before and the
law that followed that decision. But the difficulty for Mr. Bernick is not a
matter of the most accurate portrayal, but is that the accounting principles
upon which he relied bear no resemblance whatsoever to anything which could
remotely be called an accurate portrayal of his income. It was quite the
opposite – it was a most inaccurate picture. The fact that it might be
acceptable for a managing partner to dictate the use of that accounting
principle and that a Canadian accountant would prepare financial statements
based on that decree, is in no way persuasive that it, therefore, is an
accurate portrayal of income for Canadian tax purposes.
[41] The notion that because the accounting principle relied upon by
Mr. Bernick was applied in the context of a tax deferral plan somehow
bestows a legitimacy or accuracy on the computation is ill-founded. First, it
was the income in the early 1990s at issue, not the determination of income on
death. In the early 1990s a business, the Partnership, sold trading assets – it
is the income or losses from those sales which are at issue, not the gains on a
deemed disposition of Partnership units (a capital disposition by the way).
[42] This is not a matter of two accounting systems in competition for
winner of the most accurate award. The system relied upon by Mr. Bernick is so out
of whack with economic reality, that not even Mr. Wortzman's eloquent and
elaborate argument can overcome the fundamental flaw; that is, that to be
considered an acceptable system of accounting for Canadian tax purposes it must
meet the underlying fundamental criteria of accuracy in computing income. It
does not.
[43] Further, this is not a Singleton v. Canada or Ludco
Enterprises Ltd. v. Canada
situation. Mr. Wortzman's analogy that the legal characterization of a
relationship cannot be supplanted by economic reality is not a principle to be
applied when dealing with accounting principles. Accounting principles are to
be based on economic reality. It is simply a different situation.
[44] Having concluded that the method employed by Mr. Bernick does not
result in an accurate portrayal of income, it becomes unnecessary to follow the
balance of Justice Iacobucci's road map, other than to confirm that the
Respondent's portrayal of Mr. Bernick's income is accurate. By not following
the balance of the recommended process, I am left with some sense of
short-changing counsel, as I could indeed say a great deal about whether the
accounting principles relied upon by Mr. Bernick were inconsistent with
established case law principles or rules of law, or inconsistent with
well-accepted business principles. I could also go on at some length about
Bahamian GAAP, Canadian GAAP, US GAAP and international accounting standards
and the role they might have played as interpretative aids in such an analysis.
I could have carefully dissected Mr. Butler's opinion to determine how
supportive it really was, if at all. While this is all superfluous as the
prerequisite to entering such territory has not been met, I do want to, for Mr.
Wortzman's benefit, indicate, briefly, my thoughts on one aspect of Mr.
Butler's opinion.
[45] Mr. Butler's opinion of the acceptability of the accounting principles
relied upon by Mr. Bernick was premised on the UK Bond being considered a long‑term
investment. The UK Bond was not a long-term investment. It constituted
inventory to be traded in the short term. Mr. Butler's characterization was not
appropriate to this particular business. I was not, therefore, convinced that
Mr. Bernick had proven that his principle was a well-accepted business
principle. I was satisfied with the Crown's expert's testimony, that recording
acquisitions of inventory in a non-monetary exchange at its fair value was a
well-accepted business principle. Consequently, Mr. Bernick's principle was
inconsistent with well-accepted business principles.
[46] How does a sophisticated businessman come to rely on a principle for
computation of his income for Canadian tax purposes, that any reasonable
commercially-minded person would, to borrow Mr. Wortzman's phrase, recoil from?
Mr. Bernick recognized he had an economic gain, though that did not necessarily
imply to him that he had an income gain for tax purposes. This is perhaps a
matter of too much business sophistication. The less sophisticated
businessperson presumes the economic gains as taxable. The more sophisticated
presumes he can rely on what he believes is GAAP in a foreign jurisdiction to
achieve a deferral of tax in Canada, due to the very interplay between
accounting principles and taxation laws. This is an appropriate segue to the
issue of penalties.
[47] Subsection 163(2) for the years in question reads as follows:
163(2) Every person who, knowingly, or
under circumstances amounting to gross negligence in the carrying out of any
duty or obligation imposed by or under this Act, has made or has participated
in, assented to or acquiesced in the making of, a false statement or omission
in a return, form, certificate, statement or answer (in this section referred
to as a “return”) filed or made in respect of a taxation year as required by or
under this Act or a regulation, is liable to a penalty of the greater of $100
and 50% of the total of
(a) the amount, if any, by which
(i) the amount, if any, by which
(A) the tax for the year that would
be payable by the person under this Act
exceeds
(B) the amount that would be deemed
by subsection 120(2) to have been paid on account of the person's tax for the
year
if the person's taxable income for the year were
computed by adding to the taxable income reported by the person in the person's
return for the year that portion of the person's understatement of income for
the year that is reasonably attributable to the false statement or omission and
if the person's tax payable for the year were computed by subtracting from the
deductions from the tax otherwise payable by the person for the year such
portion of any such deduction as may reasonably be attributable to the false
statement or omission
exceeds
(ii) the amount, if any, by which
(A) the tax for the year that would
have been payable by the person under this Act
exceeds
(B) the amount that would have been
deemed by subsection 120(2) to have been paid on account of the person's tax
for the year
had the person's tax payable for the year been
assessed on the basis of the information provided in the person's return for
the year,
[48] There are two possibilities as to what constitutes the false statement
or omission. The first is that the false statement was Mr. Bernick's reporting
in his income tax returns of significant losses in 1992, 1993 and 1994. I have
no difficulty in finding Mr. Bernick knew he made economic gains from the
UK Bond and not losses in those years. That, of itself, does not lead however
to the conclusion that he knowingly filed false returns for tax purposes by
incorrectly reporting losses. This whole case is premised on Mr. Bernick's
belief that the differences in accounting systems allowed him to do exactly
what he did – jump through a legitimate loophole. Indeed, he presented a
Bahamian chartered accountant with Canadian training as an expert who suggested
the financial statements upon which Mr. Bernick relied may have been
appropriate even under Canadian GAAP. While I might dismiss that notion, after
hearing Professor Thornton's testimony, can I assume that Mr. Bernick was so
versed in Canadian tax laws that he should have ignored his professional
advisors and said, no, wait a minute, this does not seem right? I do not
believe so. I interpret Mr. Bernick's actions as those of a sophisticated
businessman who believes he has found a legitimate loophole in the Canadian tax
system, and has taken advantage of it. Unfortunately for Mr. Bernick, I
have found that his loophole was illusory. That finding, however, cannot be
presumed back ten years and imputed as self evident to Mr. Bernick, such that
he should have known his returns were completed incorrectly.
[49] Mr. Bernick knew he would face a tax liability. He believed that it
would occur upon his or his wife's death, and he took out the appropriate
insurance to cover that inevitability. I am satisfied that the import of a
capital gain on death as opposed to an income inclusion during life was not a
motivating factor.
[50] The evidence does suggest that Mr. Bernick arranged his affairs to
take advantage of the accounting treatment he believed was available to him. To
find that he knowingly, or under circumstances amounting to gross negligence,
made a false statement regarding the availability of losses would require proof
that he went further than simply taking advantage of the Bahamian accounting
treatment, but indeed orchestrated that treatment. Mr. Bernick may have
orchestrated the Partnership investment, but the Respondent has not proven on a
balance of probabilities that part of that orchestration involved a direction
by Mr. Bernick to Mr. Toothe, the managing partner, and to Mr. Jones, the
auditor, that the Bonds must be recorded at maturity value. In other words, Mr.
Bernick did not set the accounting treatment to be followed, but he did take
advantage of the perceived acceptable accounting treatment once known. The onus
is on the Crown to prove Mr. Bernick's false statement with respect to losses.
They did not call either Mr. Toothe or Mr. Jones. They received no
evidence from Mr. Bernick that he made any demands regarding the accounting
treatment. Failing that, I cannot find that Mr. Bernick acted falsely or with
gross negligence in reporting losses.
[51] I portray the circumstances in terms of Mr. Bernick trying one on with
CCRA, based on the perceived idiosyncrasies of foreign accounting principles.
His efforts have not proven successful.
[52] The second possibility of the false statement or omission is the
presentation of the financial statements themselves; firstly, by recording the
UK Bond at its maturity value, and secondly, by the omission of not indicating
that the UK Bond was recorded at its maturity value. Certainly, the financial
statements do indicate the current value, but they do not indicate that the
value shown as cost is the maturity value. Mr. Wortzman argued that the
statements' intended users, the partners, all were aware of that. While I have
found that the financial statements did not reflect a true and accurate picture
of Mr. Bernick's income for Canadian tax purposes, were the statements in the
financial statements false or was there an omission? Mr Bernick did not
directly make the statement or omission, but in filing the financial statements
with his returns, he did participate in, assent to or acquiesce in their
making. To be penalized under subsection 163(2), the statements must be false
"for purposes of this Act". I accept that Mr. Bernick believed
that the financial statements were true in accordance with Bahamian GAAP. That
is not the test. Did he believe they were true for purposes of the Income
Tax Act of Canada? The onus is on the Crown to prove that on a balance of
probabilities. What has been proven in that regard?
1. Mr. Bernick was put in touch
with Mr. Thornton prior to the formation of the Partnership.
2. The formation of the
Partnership, transfer into the Partnership of the UK Bond by a third party in
exchange for units; and purchase of 90 per cent of the units by Mr. Bernick
from the third party all happened within a very short period of time.
3. Mr. Bernick was a sole
investment advisor with the Partnership.
4. Mr. Bernick would not normally
invest in bonds such as the UK Bond – his expertise was with the fire and
marine convertible bonds.
5. Mr. Bernick offset significant
income in each of 1992, 1993 and 1994 against the losses.
6. Mr. Bernick went through a
similar exercise in later years through Sycamore Investments.
7. The financial statements
recorded the cost of the UK Bond at an amount equivalent to its maturity value
without revealing explicitly it was a maturity value and without revealing the
nature of the marketable securities.
8. The financial statements were
prepared by a Canadian chartered accountant who stated they were prepared in
accordance with GAAP.
9. Mr. Bernick saw the September 4,
1994, Partnership balance sheet, which recorded the UK Bond at maturity value
in 1992.
10. Mr. Bernick reviewed the 1992
financial statements in the spring of 1993.
11. Mr. Bernick received advice from
accountants that he could offset the losses against his income.
[53] The evidence supports the position that Mr. Bernick knowingly entered
a tax-avoidance plan, but falls short of establishing a knowledge that the plan
was doomed to fail. In other words, he hoped and believed that the losses would
be acceptable to the Government of Canada. There was no evidence he received
any advice to the contrary. The financial statements were integral to the plan.
I accept that he believed the statements were true vis-à-vis what they
stated. What they did not say however is another matter.
[54] The financial statements could have been more clearly stated. They
could have explicitly indicated that the cost of the UK Bond was recorded at
maturity value. This was an omission, and it was misleading. This is the most
that can be said of Mr. Bernick's behaviour that could possibly be caught
by the opening words of subsection 163(2) of the Act. He knowingly
acquiesced in the making of an omission, for by the time he filed his returns
he knew his favourable tax treatment hinged on the recording of the UK Bond's
cost at maturity. He knew the financial statements were not explicit in that
regard, notwithstanding an auditor confirmed they were prepared in accordance
with GAAP. Such confirmation does not preclude a finding of an omission for
Canadian tax purposes.
[55] It is not, however, the omission that leads to an understatement of
income. Even had the financial statements clearly stated the cost was at
maturity value, the issue would be the same – does the recording of the UK Bond
at maturity value create an accurate picture of profit? The determination of
the subsection 163(2) penalty is based upon taxable income computed by
adding the portion of the understatement of income that is reasonably
attributable to the omission. The understatement of income is not
attributable to the omission: it is only attributable to the accounting
principle which Mr. Bernick claims supports the recording of the UK Bond at
maturity. The Government, because of the omission, had to dig a little deeper
to get at that principle; the understatement of income flows from the
principle, not from the omission.
[56] I find there has been insufficient proof that Mr. Bernick knowingly
understated his income for tax purposes. He believed he had found a defensible
loophole. As it turns out, he has not. However, I do find that he knowingly
acquiesced in the omission of some critical information in the financial
statements filed with his returns; that is, the lack of disclosure of the
recording of the UK Bond at maturity. He is subject to subsection 163(2),
but the penalty is limited in each of the three years to $100 per year, as the
omission itself was not what lead to the understatement of income.
Conclusion
[57] Our tax laws have become such a complicated patchwork of do's and
don'ts, exemptions on exemptions, schemes within schemes, and case-law moulding
statute, that I am in this case faced with a distinguished lawyer presenting a
plausible, well-argued proposition that someone who has made an economic gain
on a trade can legitimately deduct significant losses from that trade, due to a
choice of accounting principles. As even Mr. Wortzman recognized, the immediate
and understandable reaction is to recoil from such a notion. Yet he went on to
weave a pattern of legitimacy that he hoped might lead to acceptance of such a
proposition. It has not worked. To accept Mr. Wortzman's argument would be
to place the role of GAAP, foreign or otherwise, on a higher level than the
courts have found it deserves. Generally accepted accounting principles are
interpretative aids only. The short answer in this case is that the
Partnership's financial statements do not accurately reflect Mr. Bernick's
income picture for Canadian tax purposes.
[58] What I find most unsettling is that a sophisticated businessman would
believe this could be possible. And yet I do not fault him for such a belief,
nor do I presume that he could not hold such a belief. Indeed, I have concluded
just the opposite. Mr. Wortzman argued ably as to the very possibility of such
a proposition, giving credence to such a belief. This goes to a deeper concern
that the Canadian taxpayer believes that in the complicated world of taxation
laws anything is possible – the incredible becomes credible. As in the recently
acclaimed novel, The Life of Pi, where one is drawn into being convinced
that a young man and a Siberian tiger can truly live together in a lifeboat for
260 days, on reflection it just does not seem possible. It is not. Neither are
Mr. Bernick's losses.
[59] I allow the appeal only in connection with the penalties imposed by
CCRA, referring the matter back for reconsideration and reassessment on the
basis that penalties are to be reduced to $100 each for 1992, 1993 and 1994.
Costs to the Respondent.
Signed at Ottawa, Canada, this 26th day of
June, 2003.
J.T.C.C.
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