Citation: 2013 TCC 32
Date: 20130129
Docket: 2011-3508(IT)I
BETWEEN:
VALERI TCHEBOTAR,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Docket: 2011-3509(IT)I
AND BETWEEN:
KATRINA TCHEBOTAR,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Docket: 2011-3510(GST)I
AND BETWEEN:
EKATERINA TCHEBOTAR, VALERI TCHEBOTAR,
Appellants,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Campbell J.
[1]
The Appellants, Valeri
Tchebotar and Katrina (also known as Ekaterina) Tchebotar, are husband and wife
and together they operate a business under the name “Katrina’s Fashion Design
& Alterations” from a small shop located in West Kelowna, British Columbia.
They operate the business as an equal partnership. It is an alterations and
tailoring business that repairs items such as clothing, blankets, drapes and
sofa cushions. The Appellants came to Canada from Moldova in 1992 and purchased
this business in 1999.
[2]
The Appellants were assessed
for three taxation years, 2006, 2007 and 2008, in respect to the two income tax
appeals and for the period January 1, 2007 to December 3, 2008 in respect to
the excise tax appeal. Due to the condition of the books and records, the lack
of supporting documentation and the fact that the majority of the business was
operated on a cash basis, the auditor, Gwen Nygaard, completed an indirect
verification of income audit. The audit increased reported business income, by
including unreported amounts, disallowed claimed business expenses, increased
amounts of GST collectible and disallowed income tax credits (“ITCs”) in excess
of those allowed and levied penalties.
[3]
Customers paid by
either cash or cheque. The shop contained no debit or credit card machines. The
auditor described the shop, from which the business operated, as a small
storefront with a small sales counter. Inside this counter was a “… drawer, an
old kitchen cabinet drawer that had cash and cheques …” (Transcript, page 159,
Examination-in-Chief of the auditor). In addition, the shop contained a small
change room and a work space containing the supplies, sewing machines, pressers
and irons.
[4]
When customers paid by
cheque, those cheques were all deposited. However, the cash amounts, according
to the Appellants’ submissions, were not always deposited and, instead, were
sometimes used directly for purchasing personal items such as food and for paying
bills. The sales were tracked through customer receipts, as the shop did not
contain a cash register or computer. Through those receipts, the Appellants
totalled the sales at the end of each day and recorded them in a notebook.
These totals were tracked weekly, monthly and yearly. All of the supporting
invoices were shredded, as well as the written recordings of the totals made
using those receipts (with the exception of the yearly totals).
[5]
The Appellants testified
that they destroyed all of their sales receipts because they were concerned
that the public could find and access the names and phone numbers of their customers.
According to the Appellants, they destroyed the daily, weekly and monthly
totals, even though they did not contain that personal customer information,
because it was too much paperwork to retain.
[6]
While only the
handwritten yearly sales totals were retained, the Appellants kept monthly
totals of the business expenses together with their supporting invoices.
[7]
The Appellants claim to
have received various cash loans from family members during the years and
period under appeal, however, they could not produce any documentation in
support of these loans and did not call any witnesses to verify their
testimony. According to their evidence, the cash from these loans was kept in
an envelope on the fireplace instead of being deposited to their bank account.
The cash was used to make credit card payments, buy food and pay other household
expenses. They indicated that they repaid some amounts on these loans but,
again, except for their oral testimony, there was no documentation or records
kept to support repayment.
[8]
The Appellants also claimed
that their children repaid loans during this period which the parents had
provided to them and that the Appellants then used this money to make payments
on credit cards. The primary example was the purchase by the Appellants of
furniture valued at approximately $8,000 for their daughter, Ludmilla
Tchebotar. The Appellants claimed that this amount was repaid by the daughter
from “her honeymoon money”, but there was no supporting documentation and, in
cross-examination, the daughter could not provide details of that repayment, as
it was her husband who had control over their money. She only assumed that her
husband, who was not a witness, would have repaid her parents.
Adjustments:
[9]
During the hearing, it
became apparent that a number of adjustments to the net worth analysis would be
required. Because the parties were unable to agree on the extent of those
adjustments, I directed that they provide written submissions. These adjustments
were required in order to address and correct:
(a) double-counting of
some items by the auditor;
(b) incorrect use by the
auditor of a payment analysis in respect to the credit cards instead of using
the correct method of purchase analysis;
(c) MBNA credit card
adjustments respecting only one card when, in fact, there were two cards; and
finally,
(d) addition errors by the
auditor in respect to liabilities.
[10]
Instead of specifically
addressing those adjustments as I instructed, the Appellants simply reproduced
the entire net worth containing their revised amounts but without reasons and
explanations to support those suggested adjustments. I accept the Respondent’s
proposed adjustments, as he provided an explanation to support the proposed
adjustments and attached schedules showing the calculations and effect of those
adjustments on the net worth analysis. The auditor also acknowledged the requirement
for these adjustments to her analysis.
[11]
The personal
expenditure amounts relating to restaurant and automotive that were double-counted
by the auditor were removed from the total expenditures considered in the net
worth analysis.
[12]
In calculating the
Appellants’ personal expenditures, the auditor conducted a “payment analysis”
of the credit cards when, in fact, an analysis of purchases made on those cards
should have been employed. Counsel for the Respondent outlined in his
submissions and schedules how the payment analysis was converted to the correct
purchase analysis in respect to the Appellants’ audit and the resulting
adjustments to the total personal expenditures.
[13]
In the payment
analysis, the auditor included in her total personal expenditures those
payments on the cards that had no traceable source. Such payments, which reduce
liabilities, will be reflected, however, on the balance sheet analysis.
Therefore, to correct the problem in respect to each year, the previous year-end
credit card liabilities must be subtracted from the total expenditures while
the current year-end credit card liabilities must be added.
[14]
While both Appellants
had MBNA credit cards in both 2007 and 2008, the auditor considered only one
card in calculating liabilities at year end. The Respondent’s schedules show
the adjustment to the liabilities to include balances for both cards. No
adjustment to liabilities was required for December 31, 2005 and December 31,
2006 because only one Appellant had an MBNA card in that period.
[15]
Finally, the revised
net worth schedules confirm the corrections made in respect to the auditor’s additions
of the Appellants’ revised liabilities as of December 31, 2008.
[16]
I accept all of these
adjustments as necessary and properly implemented according to the revised
schedules submitted by the Respondent.
Analysis:
[17]
It is clear in these
appeals why the auditor resorted to the net worth method in order to calculate
the Appellants’ income. Records and supporting documentation were not only
insufficient but were totally non-existent. Consequently, the information
provided in their returns could not be independently verified. Both the sales
invoices and the handwritten daily, weekly and monthly totals, that supported
the handwritten yearly totals given to the accountant, had been destroyed.
[18]
In Bigayan v. The
Queen, 2000 D.T.C. 1619, Bowman J. (as he was then), at page 1619, called
the net worth method “… a blunt instrument, accurate within a range of
indeterminate magnitude.” It is commonly referred to as a method of “last
resort” because all other methods of verification of the taxpayer’s income
figures have failed. By its very nature, the net worth method will result in an
approximation of the income of a taxpayer and generally an inaccurate one at best.
However, since we live in a self-assessing system, it is the taxpayer who will
always be in the best position to know his precise income in a particular
period of time. Where the taxpayer has retained the proper records and books,
it should be an easy task to identify the Minister’s errors in the net worth
assessment and to support the proposed changes with the supporting documentary
evidence.
[19]
In Hsu v. The Queen,
2001 D.T.C. 5459 (F.C.A.), the Court pointed out that the Minister must only
show that the taxpayer’s net worth has increased between two points in time and
that the Minister does not have to prove a taxable source of income. At
paragraph 29, the Court stated:
[29] Net worth
assessments are a method of last resort, commonly utilized in cases where the
taxpayer refuses to file a tax return, has filed a return which is grossly
inaccurate or refuses to furnish documentation which would enable Revenue
Canada to verify the return (V. Krishna, The Fundamentals of Canadian Income
Tax Law, 5th ed. (Toronto: Carswell, 1995) at 1089). The net worth method
is premised on the assumption that an appreciation of a taxpayer's wealth over
a period of time can be imputed as income for that period unless the taxpayer
demonstrates otherwise (Bigayan, supra, at 1619). Its purpose is
to relieve the Minister of his ordinary burden of proving a taxable source of
income. The Minister is only required to show that the taxpayer's net worth has
increased between two points in time. In other words, a net worth assessment is
not concerned with identifying the source or nature of the taxpayer's
appreciation in wealth. Once an increase is demonstrated, the onus lay entirely
with the taxpayer to separate his or her taxable income from gains resulting
from non-taxable sources (Gentile v. The Queen, [1988] 1 C.T.C. 253 at
256 (F.C.T.D.)).
[20]
The burden is therefore
upon a taxpayer to show, to the satisfaction of the Court, that the net worth
assessment is incorrect. In Saikely v. M.N.R., 93 D.T.C. 397,
Hamlyn J., at page 401, summed up how a taxpayer may attack such an assessment:
… A taxpayer may prove that some of his increase arose from
non-taxable receipts, such as inheritances or gambling; that his net worth at
the beginning of the period was undervalued or that his assets at the end were
overvalued; that liabilities existing at the end were omitted or undervalued;
that the money had been borrowed or that income losses were greater than
assessed. Whatever is alleged by the taxpayer must be proved by him; a mere
statement is not enough. Moreover, cogent evidence is required to disprove a
net worth assessment.
[21]
The Appellants
submitted no documentary evidence to support the handwritten yearly sales totals
that they provided to their accountant because they had destroyed all of those
records. I cannot accept the evidence respecting the family loans which the
Appellants allegedly received in U.S. currency from their American relatives.
These funds were supposedly carried across the border into Canada, kept in an envelope on their fireplace and used to pay expenses. Again, I have no
records to support this testimony. When they used this cash to pay expenses
such as credit cards, groceries, electric charges and so forth, there should
have been some records in some of those instances of the conversion of U.S. currency to Canadian, but none were produced. None of those individuals who allegedly
made those loans were called as witnesses. While affidavits were provided, none
of those had attached withdrawal information from bank accounts, credit cards
and so forth belonging to the lender. I must, therefore, reject the Appellants’
assertion respecting the loans, as it was reasonable to expect some additional
evidence, besides the Appellants’ testimony, that would support the existence
of such loans.
[22]
Similarly, I have no
evidence respecting the alleged cash payments of household expenses by the
children. Neither the father nor the son could recall even approximate
contributions. If none of the witnesses before me can provide me with a guesstimate,
how can I be expected to pull a figure out of the air to attribute to such
contributions? That is the responsibility of the taxpayers and they have been
unable to do so. I have no doubt that the adult children who were working and
living at home made some contributions, but I am unable to quantify those
amounts in any manner based on the vague evidence before me.
[23]
I might add that, if I
had been presented with some concrete and plausible evidence respecting both
the loans and cash payments, I would have allowed amounts in this regard. Vague
recollections are one thing, but the witnesses in these appeals could offer no
recollections. My observation can also be applied to the Appellants’
representations respecting credit card purchases. I require clear and precise
recollection of at least some of these purchases in order to conclude that, on
a balance of probabilities, it is more probable than not that the Appellants
made such purchases with funds given to them from outside sources. For example,
the Appellants’ daughter was unable to provide any evidence respecting when
amounts were repaid to her parents for the furniture loan, the amounts of those
payments, or the method. In fact, she testified that it was her husband who was
in charge of their money and that it was her husband who would have repaid the
loan. This does not establish that the loan was, in fact, repaid and does not
support the contention that these repaid amounts may have been used to make
credit card payments.
[24]
Finally, there is the
issue of amounts that the Appellants claim to have paid to their daughter for
working occasionally in the business. While the father stated that her rate of
pay depended on the work she completed and that he kept a record of this, the
daughter did not recollect that there was a record kept. The father had
represented to the auditor that he had no records at all of the daughter’s
wages. With such conflicting testimony and with no records to substantiate any
particular testimony, I must reject the Appellants’ contentions in this regard
as well.
[25]
It is interesting to
note that the Appellants were fastidious in recording and categorizing their
business expenses. While they were able to support those expenses with receipts
and other documentation, they shredded or otherwise destroyed all documentation
that would have supported their sales.
[26]
Gross negligence
penalties were imposed on the Appellants. The Minister has the duty to justify
its decision to impose those penalties. The authorities in this area are
numerous. In Venne v. The Queen, 84 D.T.C. 6247, Strayer J., at
page 6256, defined gross negligence in the following manner:
With respect to the possibility of gross negligence, I have
with some difficulty come to the conclusion that this has not been established
either. 'Gross negligence' must be taken to involve greater neglect than simply
a failure to use reasonable care. It must involve a high degree of negligence
tantamount to intentional acting, an indifference as to whether the law is
complied with or not. I do not find that high degree of negligence in
connection with the misstatements of business income. To be sure, the plaintiff
did not exercise the care of a reasonable man and, as I have noted earlier,
should have at least reviewed his tax returns before signing them. A reasonable
man in doing so, having regard to other information available to him, would
have been led to believe that something was amiss and would have pursued the
matter further with his bookkeeper.
In establishing whether gross negligence exists, a
number of factors must be reviewed. These include: the magnitude of the
omission in relation to the income declared, the opportunity the taxpayer has
to detect the error and the taxpayer’s education and intelligence.
[27]
The unreported amounts
of business income are significant when compared to the actual reported
amounts. Although the Appellants had difficulty with English, as it is their
second language, they recognized the importance of keeping records to support
the expenses they claimed and that this would directly affect taxes that they
would eventually owe. While using a cash basis is a legitimate way to conduct
business activities, it also requires more stringent bookkeeping so that a
paper trail is supportive of a taxpayer’s explanations of those cash
transactions. The Appellants were, in fact, in possession of those supporting
records but chose to destroy all of them, except for the expense documentation.
If they were concerned over protecting customer identity, there were
alternative options available to them for doing so, such as manually blocking
the identity information on the invoices and receipts or asking their
accountant if they were tracking sales appropriately when they were destroying
all sales invoices. In addition, there was no need to destroy the daily, weekly
and monthly handwritten totals, which supported the Appellants’ claimed income,
as they did not contain customer identity information. When asked why they
destroyed all of these records, the responses were vague and unclear. Although
they had an accountant prepare their returns, they controlled the information
and decided what to provide the accountant to complete those returns. In these
circumstances, the Minister’s imposition of penalties was justified.
[28]
In summary, I am allowing
the appeals to permit the adjustments to the net worth analysis as outlined in
the Respondent’s submissions due to the auditor’s errors and as more
specifically detailed in the supporting schedules to those submissions. The
Appellants destroyed all supporting records except those that would
substantiate their expense claims. They could not supply any concrete evidence
to support other sources of income. Simply put, they failed to meet their onus
by establishing that the net worth assessment is inherently incorrect.
[29]
Since the Appellants
provided no concrete evidence of what their actual income was in the years
under appeal and have been unsuccessful in disputing the assessment, the
appeals are allowed, without costs, to the extent only of permitting the
Respondent’s proposed adjustments to the net worth analysis. I also conclude
that the evidence justified the imposition of the penalties levied by the
Minister.
Signed at Ottawa, Canada, this 29th day of January 2013.
“Diane Campbell”
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