Citation: 2013 TCC 21
Date: 20130118
Docket: 2006-3767(IT)G
BETWEEN:
THANGAVADIVELU MURUGESU,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Docket: 2006-3765(IT)G
AND BETWEEN:
1480364 ONTARIO INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
D’Arcy J.
[1]
The Appellants have
filed two separate appeals. In the first appeal, 1480364 Ontario
Inc. (the “Corporation”) has appealed an income tax reassessment in respect of
its taxation year ending on May 31, 2002 (the “2002 taxation year”). In the
second appeal, Thangavadivelu Murugesu has appealed income tax reassessments in
respect of his 2000, 2001 and 2002 taxation years.
[2]
The two appeals were
heard together on common evidence.
Summary of
Facts
[3]
Mr. Murugesu
immigrated to Canada from Sri Lanka in 1990. He has a Grade 7 education. Because
of his limited knowledge of English, he provided his testimony through an
interpreter. I found him to be a credible witness.
[4]
Mr. Murugesu started
working for Sargent Farms Ltd. (“Sargent Farms”) in the mid-1990’s. Sargent
Farms raises chickens and rabbits. Originally, Mr. Murugesu worked as a
labourer on the farm. In 1997, he started a business, as a sole proprietorship,
of providing workers to Sargent Farms (the “service business”). These workers
performed numerous manual labour tasks relating to the operation of the chicken
and rabbit farm.
[5]
In 2001, he
incorporated the Corporation and transferred the service business to the
Corporation.
[6]
Because of his limited
knowledge of the English language, Mr. Murugesu relied on his accountant (the
“First Accountant”) to prepare and file his tax returns and the tax returns of
the Corporation. Unfortunately for Mr. Murugesu, he picked the wrong
accountant.
[7]
The income tax returns
filed for Mr. Murugesu’s 2000 and 2001 taxation years included deductions for
management fees of $38,000 and $15,750 respectively.
[8]
When reassessing Mr.
Murugesu’s 2000 and 2001 taxation years, the Minister disallowed the deductions
for the management fees and levied gross negligence penalties pursuant to
subsection 163(2) of $3,612.15 and $1,472.85 respectively.
[9]
Mr. Murugesu
acknowledges that he did not incur the management fees. However, he does not
believe he should be subject to gross negligence penalties. He testified that
he was not aware that the First Accountant had claimed the management fees on
his tax returns.
[10]
The First Accountant
reported gross revenue of $458,385 on the Company’s financial statements for
its fiscal year ending on May 31, 2002 (its first fiscal year). However, the
First Accountant only reported gross revenue of $285,588 on the Corporation’s
2002 income tax return. The Minister assessed the Corporation for unreported
income of $171,142, the difference between the amount she assumed was the gross
revenue of the Corporation ($458,558) and the $285,588 reported on the Corporation’s
income tax return. She also levied an $11,227 gross negligence penalty.
[11]
Mr. Murugesu does not
know why his accountant understated the Corporation’s gross revenue. He accepts
that the Corporation did understate its gross revenue by $171,142 on its income
tax return; however, he argues that the First Accountant also substantially
understated the Corporation’s wage expense. As a result, the unreported income
is substantially less than $171,142. He also argues that the Corporation should
not be subject to a gross negligence penalty.
[12]
The Minister assessed Mr. Murugesu personally in respect
of the $171,142 of purported unreported income. She included in his taxable
income a $171,142 shareholder benefit pursuant to subsection 15(1) of the Income
Tax Act (the “Act”) and imposed a $22,560 gross negligence penalty.
[13]
Mr. Murugesu argues
that there was no subsection 15(1) shareholder benefit in 2002 and that, in any
event, he should not be subject to a gross negligence penalty.
Corporation’s
2002 Fiscal Year
[14]
I will first consider
the Corporation’s appeal with respect to its 2002 fiscal year. The sole issue
before the Court is whether the Corporation incurred an expense for wages in
excess of the $301,305 reported on its 2002 income tax return.
[15]
The Corporation
determined the amount of its workers’ wages on the basis of its own internal
information and information provided by Sargent Farms.
[16]
Sargent Farms
maintained time cards for each of the Corporation’s workers. Sargent Farms and
the Corporation agreed on an hourly rate that Sargent Farms would pay the
Corporation for each task performed by the Corporation’s workers. They
calculated the hourly rate using a standard wage rate for a specific task plus
a mark-up. The mark-up was 18% before September 2001 and 15% thereafter.
[17]
Sargent Farms, using
the time cards and the hourly rates, prepared a weekly summary sheet which set
out the total hours the Corporation’s workers spent on each task and the agreed
hourly rate for the specific task. Sargent Farms then provided the Corporation
with a copy of the summary sheet and copies of the workers’ time cards.
[18]
The Corporation used
the summary sheet to prepare its invoice for the services it had rendered to
Sargent Farms.
[19]
The Corporation used
the copies of the time cards to calculate its workers’ wages. It is clear from
the evidence before me that the hourly rates used by the Corporation to
calculate its employees’ wages were lower than the hourly rates it used to
determine the fees the Corporation charged Sargent Farms.
[20]
Mr. Murugesu testified
that the 18% and 15% mark-ups were not sufficient to cover the Corporation’s
expenses. As a result, the Corporation had to reduce the hourly rate it paid
its workers.
[21]
Mr. Murugesu testified
that some of the workers wanted to be paid in cash with no withholdings for
CPP, EI or income tax. This required the company to, in effect, maintain two
payrolls, a “cash” payroll and a “normal” payroll. When the Corporation
received copies of the time cards from Sargent Farms, Mr. Murugesu (or his
spouse) noted on the card whether the employee was to be paid in cash (no
withholdings) or included in the normal payroll (subject to withholdings).
[22]
If the Corporation
paid the worker in cash, then Mr. Murugesu (or his spouse) would write on the
time card “cash pay” and the worker’s hourly wage rate.
[23]
I have reviewed the
numerous time cards for the workers paid in cash that are included in Exhibit
A-1. I agree with counsel for the Respondent that the hourly rates shown on the
time cards are lower than the hourly rates used to calculate the Corporation’s
fees. This is consistent with Mr. Murugesu’s testimony. Further, in my view, it
shows that the Corporation has not attempted to overstate the cash wages it
paid to certain of its workers.
[24]
The Corporation filed
Exhibit A-3 to support Mr. Murugesu’s testimony that the Corporation’s former
accountant understated the Corporation’s 2002 wage expense. That exhibit is a
schedule prepared by Sargent Farms that shows, on a weekly basis, the amounts
Sargent Farms paid the Corporation for its services and the amounts of cash
wages paid by the Corporation.
[25]
The Corporation
identified for Sargent Farms the workers who were paid in cash and their hourly
wage rates. Sargent Farms used this information, plus the times shown on the
time cards for the specific workers, to calculate the cash wages paid by the
Corporation to its workers during the Corporation’s 2002 fiscal year.
[26]
The schedule shows
total cash wages of $148,773. I accept this schedule as the most reliable evidence
before me of the cash wages paid by the Corporation during its 2002 fiscal
year.
[27]
Exhibit R-12 provides
a breakdown of the $301,305 that the First Accountant reported on the
Corporation’s 2002 income tax return as wages. This breakdown shows that $59,917
of the $301,305 was for cash wages. As a result, I have concluded that the
Corporation understated by $88,856 the wages reported on its 2002 income tax
return. This represents the difference between the actual cash wages of
$148,773 and the amount reported by the accountant, $59,917.
[28]
In summary, the
Corporation understated its 2002 income by $82,286, that is, the difference
between its unreported gross revenue of $171,142 and the $88,856 understatement
of its cash wages.
Mr. Murugesu’s 2002 Taxation Year
[29]
As I noted previously,
the Minister assumed that Mr. Murugesu
appropriated all of the unreported income of the Corporation. As a result, she
included the amount of the unreported income in his income under subsection
15(1) of the Act on the basis that the Corporation had conferred a
benefit on Mr. Murugesu.
[30]
Mr. Murugesu testified
that he did not appropriate any funds from the Corporation. He acknowledged
that the Corporation paid amounts to him; however, he testified that he
informed the First Accountant of all cash withdrawals.
[31]
A significant portion
of the cash paid to Mr. Murugesu was reported as employment income. The
Corporation issued T4’s to Mr. Murugesu for $59,829 of employment income in
2001 and 2002 (Exhibits R-9 and R-11).
[32]
Mr. Murugesu testified
that the Corporation also paid monies to his spouse. This is not surprising
since she provided services to the Corporation. The amount of her taxable
income in 2001 and 2002 was not provided to the Court.
[33]
Ms. Natalie Moore
testified for the Respondent. She is an investigations officer for the CRA.
[34]
She noted that the CRA’s
audit division referred Mr. Murugesu’s file to her. The CRA elected not to file
any criminal charges. However, Ms. Moore retained carriage of Mr. Murugesu’s
file and issued the assessments on behalf of the Minister.
[35]
During her testimony,
Ms. Moore noted that, prior to issuing the assessments, she did not speak to
Mr. Murugesu.
[36]
Ms. Moore prepared a
schedule for the period from July 23, 2001 to September 13, 2002, which lists $193,772
of withdrawals from the Corporation’s bank account (Exhibit R-16). This
schedule divides the withdrawals into the following three categories: payments
to the builder of Mr. Murugesu’s condominium, payments to Mr. Murugesu and his
family, and cash withdrawals. The cash withdrawals of $113,170 make up the
largest portion of the listed withdrawals.
[37]
Ms. Moore testified
that she did not perform an analysis of the cash withdrawals. She was not aware
that the Corporation paid some of its employees in cash. Further, the schedule
includes approximately $59,000 of withdrawals that the Corporation made after
its 2002 year-end.
[38]
I do not find the
schedule particularly helpful. It certainly does not support a finding that Mr.
Murugesu appropriated the $82,286 of income that the Corporation failed to
report on its income tax return.
[39]
The withdrawals
identified by Ms. Moore would appear to consist of the wages paid to Mr.
Murugesu ($52,182), whatever wages the Corporation paid to Mr. Murugesu’s
spouse and a portion of the $148,773 in cash payments that the corporation made
to its workers.
[40]
It is my view that the
objective evidence before me supports Mr. Murugesu’s testimony that he did not
appropriate any amounts from the Corporation.
Gross Negligence Penalty
[41]
The Minister levied
gross negligence penalties in respect of Mr. Murugesu’s 2000, 2001 and 2002
taxation years. The Minister also levied a gross negligence penalty of $11,227
in respect of the Corporation’s 2002 taxation year.
[42]
Since I have found
that Mr. Murugesu did not receive a shareholder’s benefit in 2002, the penalty
in respect of his 2002 taxation year will be removed.
[43]
Subsection 163(2)
levies a penalty on:
Every
person who, knowingly, or under circumstances
amounting to gross negligence, 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 for the
purposes of this Act, is liable to a penalty of the greater of $100 and 50% of
the total of . . . [Emphasis added.]
[44]
Pursuant to subsection
163(3), the burden of establishing the facts justifying the assessment of the
penalty is on the Minister.
[45]
As Justice Strayer stated
in Venne v. The Queen, [1984] C.T.C. 223 (FCTD) at 234:
. .
. “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 . . . .
[46]
Ms. Moore testified that she made
the decision to levy the gross negligence penalties. She testified that she
based her decision on the magnitude of the unreported amounts, the fact that Mr.
Murugesu and the Corporation made cash withdrawals and the fact that Mr.
Murugesu used some of the cash withdrawals to purchase a new condominium. She
also referred to a “rough source and applications of funds” analysis. However,
the Respondent did not provide the Court with the analysis.
[47]
Ms. Moore testified that she never
had a conversation with Mr. Murugesu or any employee of the Corporation.
Notwithstanding the fact that Sargent Farms had provided her with the
employees’ time sheets, she was not aware that the Corporation paid some of its
employees in cash.
[48]
After reviewing all of Ms Moore’s
testimony, it appears to me that she based her decision to levy the gross
negligence penalties primarily on the magnitude of the unreported income. This
in my view is not a sufficient fact, in and of itself, to justify the
imposition of the gross negligence penalties.
[49]
Mr. Murugesu testified that,
because of his very limited understanding of English and the Canadian taxation
system, he relied on the First Accountant to properly prepare and file his tax
returns. He had no idea that the tax returns filed by the First Accountant were
incorrect.
[50]
Once an official from the CRA came
to his home to discuss the problems with regard to his tax returns he
immediately fired the First Accountant and hired a new accountant.
[51]
Counsel for the Respondent did not
adduce any evidence either through Ms. Moore or through his
cross-examination of Mr. Murugesu that would undermine Mr. Murugesu’s
credibility. As I noted previously, I found Mr. Murugesu to be a credible
witness.
[52]
I note that the
Corporation deposited all of its revenue into its bank account and reported the
revenue on its financial statements. There was no attempt by the Corporation to
hide any of its revenue.
[53]
From the evidence
before me, it appears the First Accountant was negligent when preparing Mr. Murugesu’s
personal tax returns and also the Corporation’s return for its 2002 taxation
year. However, I do not believe that either the Corporation or Mr. Murugesu was
grossly negligence.
[54]
Mr. Murugesu has
worked extremely hard to establish his business. However, he is not a
sophisticated business person. Because of his limited knowledge of English and
the Canadian taxation system, Mr. Murugesu had no choice but to rely on an accountant.
He did what a reasonable person would have done in his situation: he chose an
accountant recommended by members of his community, who could speak to him in
his native language. I accept his testimony that he was not aware that the
First Accountant failed to report all of his and the Corporation’s income.
[55]
For the foregoing
reasons, I have concluded that the Minister has not established facts that
justify the imposition of the subsection 163(2) gross negligence penalty on
either Mr. Murugesu or the Corporation. Further, in light of the evidence
before me, I have concluded that Mr. Murugesu took reasonable care to ensure
that he properly filed his personal tax returns and the Corporation’s tax
return.
[56]
Accordingly, the Corporation’s
appeal in respect of its 2002 taxation year is allowed with costs. The
reassessments are referred back to the Minister for reconsideration and
reassessment on the basis that the Corporation, when filing its income tax
return, understated its income by $82,286. The subsection 163(2) gross
negligence penalty will be vacated.
[57]
Mr. Murugesu’s appeal in respect
of his 2000, 2001 and 2002 taxation years is allowed with costs. The
reassessments are referred back to the Minister for reconsideration and
reassessment on the basis that no amount should be included in his income for
the 2002 taxation year under subsection 15(1). All subsection 163(2) penalties will be vacated.
Signed
at Ottawa, Canada, this 18th day of January 2013.
“S. D’Arcy”
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