Svidal v. The Queen, [1995] 1 CTC 2692 (TCC)

Bowman J.T.C.C.:-These appeals are from assessments for the appellant’s 1984 and 1985 taxation years. By these assessments the Minister of National Revenue included in the appellant’s income for those years the sums of $393,235.97 and $57,575.78 respectively.

The essential questions are factual. The appellant alleges that the sums added to his income have either been reported as income or represented the payment for shares and as such are capital receipts or are repayment of loans. The respondent says that they are all income from the business of fraud and has opened up otherwise statute-barred years and has imposed penalties under subsection 163(2).

Mr. Svidal carried on business through a corporation Sorenson Assurance Services Ltd. (Sorenson), an insurance broker. He started to work for Mr. Sig Sorenson in 1956 and when the company Sorenson was formed in 1956 he acquired ten shares. Between 1956 and 1961 he acquired further shares of Sorenson until he owned 49 per cent of the shares. In 1976 he agreed to acquire Mr. Sig Sorenson’s interest for $151,500. That agreement was subsequently amended and he agreed to pay, over time, $176,000. In 1978 he paid a lump sum, being, apparently, the discounted value of the balance of the purchase price and thereby satisfied his obligation to Mr. Sorenson.

In 1973 one Mr. Geoffrey B. James came to work for Sorenson and in 1974 Mr. Brian Szott was hired. As the result of a series of transactions, Mr. Szott and Mr. James each acquired from the appellant 40 shares or 20 per cent of the outstanding shares of Sorenson.

In 1978 two new employees, Mr. Kenneth Mutlow and Mr. Garry Anderson joined the company and they acquired an interest in 1978. Mr. Anderson bought ten shares from Mr. Szott and 20 from the appellant. Mr. Mutlow bought ten shares from Mr. James and 20 from the appellant. The result was that the shareholdings in 1978 were as follows:

Appellant: 79

Appellant’s wife: 1

Mr. James: 30

Mr. Szott: 30

Mr. Anderson: 30

Mr. Mutlow: 30

On October 15, 1979 Sorenson bought Mr. Szott’s 30 shares back from him and Mr. Szott left the company, evidently because of a disagreement with Mr. Anderson and Mr. Mutlow. In 1980 Mr. Anderson and Mr. Mutlow left the company and their shares were also repurchased by Sorenson.

In about 1980 the appellant borrowed $290,000 and advanced $100,000 to Sorenson.

Both the viva voce testimony and the documentary evidence including the financial statements of Sorenson support the finding of fact that at least as late as 1983 Sorenson owed the appellant $100,000 and the appellant deducted the interest on the $100,000 in computing his income.

Mr. Szott had left Sorenson in 1979 but in 1982 he came back having become involved with a company known as Group Benefits Corporation (GBC). GBC was engaged in a business of selling group insurance benefits that would initially be insured with a domestic company which would retain a small portion of the risk and reinsure the largest part with an offshore captive insurance company in Bermuda. According to Mr. Svidal this resulted in substantially larger commissions, although the reason for this was not made clear.

Also, through Mr. Szott, Sorenson bought the insurance agency business of Ardon Assurance Services as well as of Brandon Insurance Services Ltd. Brandon Assurance was to obtain a 25 per cent interest in Sorenson through a share issuance in which the provisions of section 85 of the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.) (the "Act”) would be used.

In any event, some time later, in about 1984, Sorenson and the appellant, as well as Mr. James, (the minority shareholder in Sorenson), Mr. Szott and one Mr. William Blythe became involved in an elaborate and mammoth fraudulent scheme designed to extract large sums of money from the Canadian Commercial Bank and the Northlands Bank. These banks subsequently failed. Eventually they were convicted of a number of counts of fraud against those banks and sentenced to terms of imprisonment. They were Said to have defrauded the banks in the total amount of about $26,000,000.

The scheme in simple outline involved the creation of group insurance contracts with various groups, such, for example, as the Alberta Teachers Association, Canada Safeway Auto and Homes Group Plan, and the Western Denturists Group to mention only a few. The contracts were bogus but the banks, inexplicably, accepted them as real and advanced upwards of $26,000,000 with these bogus contracts as security. The money so advanced filtered its way down through a series of corporations which were no more than conduits. These corporations included World Wide Diamonds, Sorenson, GBC, 109049 Holdings Ltd., 315356 Alberta Ltd., and 319959 Alberta Inc. Some of these companies had more than one bank account at different banks. The evidence establishes that some of the money ended up in the trust account of a firm of Edmonton lawyers, Vickerson and Hankinson. About $14,000,000 found its way back to the banks by equally circuitous routes as loan repayments.

All in all Mr. Svidal, the appellant, received in 1984 and 1985 a total of $450,811.75 upon which the Minister assessed him in addition to the income declared by him in his returns of income. It was made up as follows:

It is admitted that all of these amounts were received by him in the years indicated.

I have concluded on the evidence that all of these moneys came originally from the fraudulent scheme engaged in by the appellant and his associates Mr. Szott, Mr. James and Mr. Blythe. I base this conclusion upon the testimony of Mr. Ian Peter Schofield, a forensic chartered accountant who put in evidence a report in which he traced in great detail and with meticulous care the flow of funds from the two banks through the different companies and bank accounts ultimately to the appellant.

There is no basis in the evidence upon which I could conclude that any of the funds which he received came from any of the "legitimate" insurance brokerage activities of Sorenson.

The tracing of the funds by Mr. Schofield was detailed and thorough. I need not reproduce it here. It can be summarized briefly as follows.

The four $10,000 cheques to Mr. S vidal as well as the $45,000 cheque were drawn on a bank account of 109049 Holdings Ltd., which had no source of funds other than those derived ultimately from the fraudulent borrowing from the banks.

The $50,000 payment to Mr. Svidal was made from the trust account of Vickerson and Hankinson. The $301,735.97 also came from that trust account and was paid to a mortgage company in satisfaction of two mortgages owing by Mr. Svidal. Vickerson and Hankinson received their funds to make these payments from 109049 Holdings Ltd. or from GBC.

The $7,575.78 was returned to 109049 Holdings Ltd. by Vickerson and Hankinson and was then paid to Mr. Svidal.

The $6,500 came from 109049 Holdings Ltd. This is based upon the analysis of the cash flow between the companies and the numerous bank accounts. The cheque for this amount was not produced, but it is admitted that the appellant received it.

One final piece of evidence should be noted. In 1985 Coopers and Lybrand Limited, as receivers for the banks, seized the business of Sorenson and effectively closed it down. In 1991, following his conviction, Mr. Svidal, in addition to being sentenced to eight years in prison, was ordered by Mr. Justice MacCallum to pay compensation of $10,075,735.55 to Coopers and Lybrand Ltd., receivers for the banks. He has not paid any portion of this. At the time of the trial in this Court he was out on parole.

Counsel for the appellant in an ingenious and extremely able argument, seeks to extricate his client from the difficult situation in which he finds himself by a number of arguments which boil down essentially to the following:

A. He admits that Mr. Svidal was involved in a scheme to defraud the banks and that he was convicted. He does not invite me to reconsider the verdict reached by the jury. Accordingly it is unnecessary for me to consider the application of issue estoppel or res judicata, as those doctrines have been analyzed in M.N.R. v. Van Rooy, [1988] 2 C.T.C. 78, 88 D.T.C. 6323, and Angle v. M.N.R., [1975] 2 S.C.R. 248, 74 D.T.C. 6278. He also admits that his client received the funds and he did not attempt to show that the amounts received by him are not ultimately traceable to the funds that were fraudulently obtained from the banks.

B. He contends, however, that the receipt of funds received by Mr. Svidal should in part be recharacterized as something other than income. Specifically, $100,000 should be treated as the repayment of the $100,000 loan made by Mr. Svidal to Sorenson and a substantial portion should be treated as either proceeds from the repurchase by Sorenson of the appellant’s shares or as proceeds from the sale by him of his shares to a holding company as part of a corporate reorganization.

C. He contends further that the $50,000 cheque received by him has already been declared in income by him as a director’s fee from Sorenson and should not be included again.

D. He contends that the destruction of Sorenson’s business resulting from its seizure by Coopers and Lybrand Ltd. gives rise to a deemed disposition within the meaning of section 50 of the Income Tax Act and accordingly he is entitled to an allowable business investment loss within the meaning of paragraph 38(c).

E. He contends that the amount of $10,075,735.55 that he was ordered to pay to Coopers and Lybrand Ltd. is a deductible expense in computing income from the business that the Minister has characterized as the business of fraud and that it is deductible in 1984 notwithstanding the fact that the order was made in 1991.

F. He contends that the necessary negligence, carelessness or wilful default required to permit the reopening of the 1984 taxation year under paragraph 152(4)(b) has not been established and that the conditions in subsection 163(2) "knowingly...or under circumstances amounting to gross negligence" necessary to justify the imposition of penalties have not been established.

I shall deal with each of these points in order:

A. and B. It is settled law that proceeds from criminal activities are taxable income. I can think of no circumstances in which such income cannot be characterized as income from a business. In the Department’s letter in which it proposed the adjustments to the appellant’s income, it is stated that the proposed additions to income are "income from a source”. It is in vogue these days to speak of "income from a source" as if income were capable of arising in the abstract independently of any specified source. The concept is innocuous, but its correctness is open to question. There is no such thing as income from a source that cannot be identified. In the reply to the notice of appeal the amounts added to the appellant’s income are described as income from the business of fraud. The Income Tax Act requires that a taxpayer be taxed on income from all sources inside or outside Canada, including offices, employments, businesses and properties. Other sections of the Income Tax Act, contained in subdivision D of Division B require the inclusion in income of amounts from other specified sources-such, for example, as trusts, RRSPs, pensions and many other sources not covered by the words "property, business or employment". Beyond the sources specified in the Income Tax Act it is difficult to conceive of any other sources of income. [1]

The amounts received by the appellant are income from a business and they retain that quality irrespective of the number of corporate entities and bank accounts through which they pass. The illegality which gave rise to the profits permeates the funds and follows then into the hands of their ultimate recipient, in this case the appellant. The illegality is not filtered out by passing through or into a series of entities or forms. Indeed the circuitous progression of the funds through the various entities was an integral part of the scheme. [2]

For this reason alone, and even if I accepted that a portion of the funds was received by the appellant as the repayment of his $100,000 loan or as proceeds from the disposition of shares, I would still consider the amounts to income in Mr. Svidal’s hands.

I do not, however, accept that on the evidence the funds were used to pay off the amount owing to him by Sorenson or to pay for his shares. On this point a number of contradictory theories were advanced by Mr. Svidal in his conversations with officials of the Department of National Revenue, Ms. Mah and Mr. McNeil, both of whom gave evidence. At one point he said the funds were used to repay loans and subsequently he said that they were proceeds from the sale of shares as part of a corporate reorganization. Although it is true that the $100,000 loan seems to have disappeared from Sorenson’s books by the end of 1984 there is insufficient evidence in my view to support a finding that any portion of the moneys received in 1984 were used to pay off the loan. As to the corporate reorganization, whereby the shares were said to have been either sold to a holding company or repurchased by Sorenson, the short answer is that it never happened. All of these theories are simply ex post facto rationalizations. The income from the scheme that Mr. Svidal received was his income and it has not been established that it was the income of any entity antecedent in the chain.

C. I agree that a prima facie case has been made out that the $50,000 cheque received from the Vickerson and Hankinson trust account is probably the amount that the appellant declared in his 1985 tax return. There is no evidence of his having received any other $50,000 amount and even though the cheque has on it a notation indicating that it was in respect of GBC it is not surprising that he might have thought it was a director’s fee in respect of Sorenson and so designated it in his return. I think that the position that is more consistent with the evidence is that the Minister has erred in including the same amount of $50,000 twice. Even though the appellant’s income has been derived from a fraudulent scheme he does not deserve to be taxed twice on that income on the basis of some conjectural theory that there might have been another $50,000 amount floating about that has not been detected. He has paid heavily for his involvement in the scheme.

D. On the evidence I do not think that it has been established that the appellant suffered an allowable business investment loss in respect of either the loan or the shares of Sorenson in 1985. The seizure of the company’s business by Coopers and Lybrand Ltd. was no doubt a crippling blow to it but it has not been established that it became insolvent in 1985. Moreover, under clause 50(1 )(b)(iii)(B) of the Income Tax Act one of the conditions necessary to the application of subsection 50(1) is that the taxpayer should have elected in the return of income for the year to have the subsection apply. No such election was made and the appellant’s notice of objection does not constitute a notification before December 11, 1993 of the type contemplated by the transitional legislation implementing the amendment of subsection 50(1). Indeed the matter of an allowable business investment loss was not raised until the amended notice of appeal was filed.

E. One of the most ingenious and intriguing arguments was that relating to the effect on the appellant’s 1984 and 1985 taxation years of the compensation order made by the Alberta Court in 1991, whereby the appellant and his co-accused were ordered to pay to Coopers and Lybrand Ltd. the sum of $10,075,735.55. The contention is that this amount should, in the computation of the appellant’s income from the business, characterized by the Crown as the business of fraud, be allowed as a deduction. The argument, if I understand it correctly, is that the obligation to repay the amounts was crystallized by the compensation order of 1991 but that since it relates to the business carried on in 1984 and 1985 it should be allowed as a deduction in those years.

The argument raises more problems than I am prepared to discuss here. Implicit in it is the theory that income from crime is to be computed on an accrual basis-a proposition in respect of which I have heard neither legal authority nor expert accounting testimony. Also it implies that as soon as a crime is committed there arises an inchoate liability which is only fixed if after conviction the accused is ordered to make a compensation payment or restitution. Also, it raises the question whether such payments should be allowed as deductions as a matter of public policy. As noted above the appellant has made no payments under the compensation order and there is no evidence that he ever will. The argument seems not dissimilar to that unsuccessfully advanced in The Queen v. Poynton, [1972] C.T.C. 411, 72 D.T.C. 6329 (Ont. C.A.).

Interesting as it might be to pursue these theoretical questions it is sufficient to dispose of the point to say that the compensation order was made in 1991 and can have no effect on the appellant’s 1984 and 1985 income. Our fiscal system does not, except in specific circumstances set out in the Income Tax Act, permit the reopening of prior years to take into account events occurring in later years: M.N.R. v. Benaby Realties Ltd., [1968] S.C.R. 12, [1967] C.T.C. 418, 67 D.T.C. 5275.

E. So far as opening up the otherwise statute-barred taxation year 1984 and the imposition of penalties is concerned, there is ample evidence that the appellant in failing to declare the amounts of income which have been added by the Minister made a misrepresentation that is attributable at least to negligence or carelessness-in my view gross negligence-and was that he made false statements in his returns under circumstances amounting to gross negligence. Failing to declare upwards of $400,000 in income is not an inadvertent slip. Accordingly the opening up of the 1984 taxation year and the imposition of penalties was justified.

The appeal from the assessment from 1984 is dismissed. The appeal from the assessment for 1985 is allowed and the assessment referred back to the Minister of National Revenue for reconsideration and reassessment to delete the sum of $50,000 and to adjust the penalties and interest assessed accordingly.

The respondent, having been substantially successful, is entitled to her costs.

Appeal for 1984 dismissed; appeal for 1985 allowed.