Buckman v. MNR, 91 DTC 1249, [1991] 2 CTC 2608 (TCC)

Sobier, T.C.J.:—The appellant through his trustee in bankruptcy, Price Waterhouse Ltd., appeals from the reassessments for the 1983, 1984 and 1985 taxation years, of the respondent whereby the respondent inter alia;

(a) included in the appellant's income for 1983 an amount of $240,000 on account of unreported misappropriations from clients and allowed as a deduction an amount of $36,000 on account of interest expenses;

(b) included in the appellant's income for 1984 an amount of $76,000 on account of unreported misappropriations from clients and allowed as a deduction an amount of $39,150 on account of interest expenses, and;

(c) included in the appellant’s income for 1985 an amount of $206,000 on account of unreported misappropriations from clients and allowed as a deduction an amount of $94,155 on account of interest expenses.

The following are the facts as agreed upon by the parties in an agreed statement of facts:

1. Buckman made a voluntary assignment in bankruptcy on July 22, 1986.

2. Price Waterhouse Ltd. (formerly Laventhol & Horwath Ltd.) (the "Trustee") was appointed as trustee in bankruptcy, which appointment was confirmed at a meeting of creditors on September 2, 1986.

3. Prior to his voluntary assignment in bankruptcy, Buckman was a sole practitioner, practising law in the Province of Ontario.

4. Mr. Buckman’s misconduct commenced in 1982 following serious losses which he had suffered in relation to his personal investments, including bad loans, high interest and covering losses for clients on bad investments recommended by Mr. Buckman.

5. Between 1983 and 1985, Buckman embezzled money from several people as follows:

(a) 1983—$240,000 from Louis and Rose Awenus. In one transaction, Buckman did not notify these clients that a mortgage in which they had invested had been discharged. Buckman kept the money and paid interest to the clients, leading them to believe that the mortgage was still in existence. With respect to four other mortgages, Buckman gave the clients documents purporting to be mortgages in which they were the mortgagees. In support of the false documents, Buckman advanced interest payments to them.

(b) 1984—$50,000 from Clarence Skrepnek. Buckman gave this client documents purporting to be a mortgage with the client as the mortgagee. Buckman made interest payments to the client under the pseudonym of K. Denise. There was no mortgage.

(c) 1984—$26,000 from Ross Ballentryre. Buckman gave this client a document purporting to be a mortgage with the client as the mortgagee. Buckman made interest payments to the client under the pseudonym of K. Denise. There was no mortgage.

(d) 1985—$35,000 from Ruth Gorewich. Buckman gave this client documents purporting to be a registered mortgage with the client as the mortgagee. Buckman made interest payments to the client under the pseudonym of K. Pagel. There was no mortgage.

(e) 1985—$75,000 from Jeff Wagli. Buckman acquired money under the pretext of investing it in a mortgage on behalf of this client at a purported rate of return of 50 per cent. The client received payments for a period of time, however, he had no security and there was no mortgage.

(f) 1985 —$30,000 from Domenic Amato and Antio DiMaria. Buckman acquired money under the pretext of investing it in a real estate project. Buckman gave these clients a personal promissory note with a rate of return of 50 per cent. Payments were made for a short period of time.

(g) 1985—$66,000 from Kathy Kliensteuber. Buckman acquired the money on the pretext of investing it into a mortgage. Buckman did not give this client mortgage documents, however, he did give her a series of postdated cheques. There was no mortgage.

6. All of the clients referred to in paragraph 5, above, understood that they were dealing with Mr. Buckman in his capacity as lawyer or mortgage broker.

7. In the 1983, 1984 and 1985 taxation years, Buckman, in an attempt to avoid the discovery of his wrongdoing, made interest payments to certain of the clients referred to in paragraph 5 above.

8. Some or all of the funds referred to in paragraph 5, above, may have been used to pay interest to the clients or repay principle [sic] on moneys already stolen.

9. The amount of funds misappropriated and the interest payments made with respect thereto are as follows:

	1983	1984 1984	1985 1985
Stolen Funds	$240,000	$75,000	$206,000
Interest Paid	36,000	39,150	94,155
	$204,000	$36,850	$111,845

10. Buckman was charged with and convicted of numerous counts of fraud for his activities in connection with misappropriation of clients’ funds.

11. None of the moneys referred to in paragraph 5, above, has since been repaid and each client has filed a proof of claim with the trustee in bankruptcy.

12. On July 8, 1988, Notices of Reassessment were issued by Revenue Canada, Taxation for the 1983, 1984 and 1985 taxation years, adding to Buckman’s income the amounts of misappropriated funds set out above and allowing as deductions the interest paid to certain of his clients in the said taxation years in an attempt to avoid being discovered.

13. On October 29, 1990, the reassessments were confirmed.

The appellant's position is that the embezzled funds (the "Funds") were not income in his hands. He contends that "income must be designated as derived from a particular source which may be:

i) office;

ii) employment;

iii) business;

iv) property; or

v) other source." (appellant's factum ("A.F."), page 2)

He also contends that once the particular source of a receipt is determined, that receipt is taxed in accordance with the rules applicable to that particular source (A.F., page 2).

Since the Funds were misappropriated in the course of [the appellant's] law practice, the source, if any, must be business (A.F., page 3). Accordingly, his income for a taxation year from a business is his profit therefrom for the year (A.F., page 3).

To determine "profit", says the appellant, generally accepted accounting principles (“GAAP”) will govern unless there are specific provisions in the Income Tax Act (the "Act") which require a departure from GAAP (A.F., page 4).

Under GAAP, the Funds would not be included in profit from a business and therefore could not be "income" from a business, since the appellant did not have use of the Funds absolutely without restriction since they, at all times, belonged to their rightful owners. In addition, by making payments to the rightful owners which he claims were interest payments, he became a borrower of the Funds (A.F., page 4).

The appellant claims that because he recognized his obligation to repay the Funds, he is to be treated as a borrower rather than a thief (A.F., page 5). Finally, he contends that the misappropriation of the Funds in the course of carrying on a business is a situation different from other “illegal businesses" such as gambling, prostitution, bootlegging etc. where receipts of business are paid voluntarily (A.F., page 5).

The respondent has adopted two alternative positions. The first is that the receipt of the Funds is income from a source and therefore taxable under section 3 of the Act. The second, that receipt of the Funds was income from a business and taxable even though the Funds were received from illegal operations.

Mr. L.S. Rosen, a professor of accounting, was called by the appellant as an expert witness to deal with the characterization of the receipt of the Funds according to GAAP. It was his contention that under GAAP, the receipt of the Funds created a liability of the appellant and not as capital or revenue and that to paraphrase his words, a one-sided transaction can never be included in income. In addition, it was his evidence that since no goods or services were provided by the appellant, receipt of the Funds could not be income and since the appellant paid interest to the defrauded clients, he acknowledged his liability.

Dealing first with the characterization of the receipt as a liability, the appellant arrives at this position in two ways. He eliminates two of the three possibilities leaving liability as the remaining one. He also states that by paying interest, he acknowledges the indebtedness. While there is a liability to repay the Funds, this does not close the door on another characterization. I will deal with this later in these reasons.

What Mr. Buckman paid to his clients was not interest. It was money paid to have them believe they were receiving interest which was due from third parties. Mr. Buckman's scheme was to make it appear he had put the Funds out for investment as he promised and therefore the argument that the payment of interest created a lender/borrower relationship fails.

As to the receipt of the Funds being characterized as a liability on Mr. Buckman's part under GAAP by reason that it could not be an income or capital receipt, one must examine whether in fact GAAP is of assistance in this case in determining the nature of the receipt.

Dealing with determining profit from a business, the law is succinctly set out in Associated Investors of Canada Ltd. v. M.N.R., [1967] C.T.C. 138; 67 D.T.C. 5096 (Ex. Ct.) at page 143 (D.T.C. 5099) where Jackett, P. stated:

Profit from a business, subject to any special directions in the statute, must be determined in accordance with ordinary commercial principles. (Canadian General Electric Co. v. M.N.R., [1962] S.C.R. 3; [1961] C.T.C. 512 at 520; 61 D.T.C. 1300, per Martland, J. at page 12.) The question is ultimately "one of law for the court". It must be answered having regard to the facts of the particular case and the weight which must be given to a particular circumstance must depend upon practical considerations. As it is a question of law, the evidence of experts is not conclusive. My first task is therefore to determine the proper treatment of the amounts in question in accordance with ordinary commercial principles. Having ascertained that, I must consider whether any different treatment is dictated by any special provision of the statute.

In The Queen v. Metropolitan Properties Co., [1985] 1 C.T.C. 169; 85 D.T.C. 5128 (F.C.T.D.), the taxpayer was allowed to deduct development costs as current expenses whereas under GAAP, they should have been reported as additions to the cost of the land inventory. There the Court held that although GAAP should normally be followed for taxation purposes, where it is justified or required by legislation or contrary to commonly accepted business or commercial practice, GAAP need not be followed. I would add that no accounting system need be followed where its application would be contrary to the reality of the circumstances to which it is sought to be applied and would in fact distort the true picture of the taxpayer's tax position.

The question to be determined by this Court is whether the receipt of the Funds is income. In M.N.R. v. Publishers Guild of Canada Ltd., [1957] C.T.C. 1; 57 D.T.C. 1017 (Ex. Ct.) in dealing with the opinion of accountants and the responsibility of the Court, Thorson, P. said at page 17 (D.T.C. 1026):

But the Court must not abdicate to accountants the function of determining the income tax liability of a taxpayer. That must be decided by the Court in conformity with the governing income tax law. It is an established principle of such law in this Court that there is a statutory presumption of validity in favour of an income tax assessment until it is shown to oe erroneous and that the onus of doing so lies on the taxpayer attacking it.

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 . . .

Further commenting on the applicability of GAAP, Urie, J.A. states at page 64 (D.T.C. 5034) of The Queen v. Nomad Sand and Gravel Ltd., [1991] 1 C.T.C. 60; 91 D.T.C. 5032 (F.C.A.):

Among those principles is that which recognizes that according to generally accepted accounting principles, sums received by a taxpayer should be recorded in a taxpayer's financial statements, in the way which most nearly reflects its actual financial position at any given time or for any given period, but for purposes of ascertaining the taxpayer's income for tax purposes the receipt of the sums may require to be recorded differently. In Neonex International Ltd. v. The Queen, (4) I had occasion to express the principle in this way:

There is no doubt that the proper treatment of revenue and expenses in the calculation of profits for income tax purposes with a view to obtaining an accurate reflection of the taxable income of a taxpayer, is not necessarily based on generally accepted accounting principles. Whether it is so based or not is a question of law for determination by the Court having regard to those principles (see M.N.R. v. Anaconda American Brass Ltd. (1956), A.C. 85; [1955] C.T.C. 311; 55 D.T.C. 1220; see also Associated Investors of Canada Ltd. v. M.N.R., [1976] Ex. C.R. 96; [1967] C.T.C. 138; 67 D.T.C. 5096).

Therefore, I conclude that the opinion of Mr. Rosen as to the application of GAAP to the case at bar does not override the greater principle that the Court must determine the question of law relating to the issue of taxability of the receipts.

Viscount Haldane speaking for the Judicial Committee of the Privy Council in Smith v. A.-G. Canada, [1917-27] C.T.C. 251; 1 D.T.C. 92 dealt with the issue of the taxability of unlawful businesses at page 254 (D.T.C. 93) where he said:

Nor does it seem to their Lordships a natural construction of the Act to read it as permitting persons who come within its terms to defeat taxation by setting up their own wrong. There is nothing in the Act which points to any intention to curtail the statutory definition of income, and it does not appear appropriate under the circumstances to impart any assumed moral or ethical standard as controlling in a case such as this the literal interpretation of the language employed. There being power in the Dominion Parliament to levy the tax if they thought fit, their Lordships are therefore of opinion that it has levied income tax without reference to the question of Provincial wrongdoing.

Counsel for the appellant referred to the dissenting opinion of Mr. Justice Black of the United States Supreme Court in James v. United States, 61-1 U.S.T.C. 9449. In James, the majority of the U.S. Supreme Court overruled Commissioner v. Wilcox, 46-1 U.S.T.C. 9188 (U.S.S.C.) by holding that embezzled funds are includable in income and taxable. However, counsel still urged the Court to ignore the majority decision and apply Mr. Justice Black's dissenting opinion. However, there was no doubt in James that the previous position in Wilcox was overruled and the law concerning the treatment of embezzled funds was from thenceforth changed.

Counsel also referred to Gilbert v. Commissioner of Internal Revenue, 582 F. 2d 478 (1977, 2d Cir.). That case is distinguished by the single fact the appellant in Gilbert fully intended to repay the funds; whereas, it is clear Mr. Buckman was embezzling the Funds with no intention to repay. He did all in his power to keep his clients in the dark concerning his activities. Mr. Gilbert did not attempt to hide the fact. "He immediately informed several of the corporation's officers and directors and he made a complete accounting to all of them within two weeks". (Gilbert, supra, at page 481.) The lack of intention on the appellant's part to repay the funds may be deduced from the delivery of false documents as well as the payment of so-called interest to the clients. These actions were in furtherance of the deception.

The Queen v. Poynton, [1972] C.T.C. 411; 72 D.T.C. 6329 (Ont. C.A.) is the leading authority dealing with fraudulently obtained funds as income. There, the respondent fraudulently acquired about $21,000 of funds from the company in which he was a director and secretary-treasurer. The Court of Appeal held that the money was taxable in his hands as a benefit to an officer or employee under subsection 5(1) of the Act.

In his reasons for judgment in Poynton, Evans, J.A. quotes with approval the reasons of Lord Haldane in Smith, supra. The argument in Poynton that the moneys did not have the quality of income since the appellant did not enjoy the right to the moneys absolutely, with no restriction, contractual or otherwise, as to its disposition use or enjoyment was put to rest.

At page 417 (D.T.C. 6334), Evans, J.A distinguished Robertson v. M.N.R., [1944] Ex. C.R. 170; [1944] C.T.C. 75; 2 D.T.C. 655 and Dominion Taxicab Association v. M.N.R., [1954] S.C.R. 82; [1954] C.T.C. 34; 54 D.T.C. 1020 when he referred at pages 417-18 (D.T.C. 6334) to Curlett v. M.N.R., [1961] C.T.C. 338; 62 D.T.C. 1320:

The facts in the latter case are fully reported in [1961] Ex. C.R. 427; [1961] C.T.C. 338; 62 D.T.C. 1320 and indicate that Curlett bought mortgages at a discount which he then sold at face value to a private company in which he had absolute control and undisputed ownership. The trial Court held that the bonus money retained by the taxpayer was income from a business venture carried on personally by him and completely separate from that carried on by the private company. Curlett sought to escape liability on the basis that his actions constituted a fraud on the private company and that the proceeds of the discounted mortgages lacked the essential quality of income in his hands, as his right to them was not absolute, and that he was under a duty to account and pay over same to the company. The Court noted that several years had passed during which Curlett had made no effort to pay over the discounts to the company which he controlled. There can be no doubt that the taxpayer was in breach of his fiduciary duty to the company and that the company was entitled to the discounts which were improperly retained by Curlett. The Court in holding that the moneys constituted income in the hands of Curlett did so in the face of his defence that he was under a duty to account and that his entitlement was not absolute. The principle to be elicited from the judgment, as I comprehend it, is that strict legal ownership is not the exclusive test of taxability but that a Court in determining what is income for taxation purposes must have regard to the circumstances surrounding the actual receipt of the money and the manner in which it is held. The. fact that the Court stated that the money was “income from a business” indicates the scope and extent of the operation but does not affect the basic finding that money accruing in such a manner whether as the result of an isolated transaction or from a series of transactions, is taxable income. The Supreme Court of Canada, on October 10, 1962, dismissed an appeal from the bench and adopted the conclusion reached by the trial Judge.

In both Robertson and Dominion Taxicab cases, the Courts were dealing with moneys subject to obligations and restrictions set out in written contracts. I believe them to be readily distinguishable on the facts from Curlett and the case at bar. If one receives money under a trust for another, he is under an obligation to turn over the proceeds to his cestui qui trust. If he does so then he fulfils his duty and no question of taxability qua trustee arises. If however, in breach of his duty to account, the trustee converts to his own use he is taxable, not on the basis that the quality of the money or his entitlement thereto has changed, but on the basis that the manner of holding has altered. The moneys are still trust moneys and the trustee is liable in law to account but because of the theft or conversion the trustee in reality holds the money for his own account. The fact that a defaulting trustee may be called upon to return his ill-gotten benefits flows from his relationship to his cestui qui trust while his taxability results from the manner in which he actually holds the benefit.

It has argued on behalf of the respondent that there is something repugnant in the taxation of moneys in the hands of a thief because it places the rightful owner in contestation with government over money which properly belongs to him. Whatever merit there may be in such argument, it hardly lies in the mouth of the thief to advance it. The solicitude of a thief for the financial welfare of his victim must be viewed with suspicion and my only observation is that in practice the likelihood of such a contestation would infrequently arise and in any event it is a legislative rather than a judicial problem.

Later at pages 419-20 (D.T.C. 6335), Mr. Justice Evans went on to say:

I am of the opinion that there is no difference between money and money's worth in calculating income. They are both benefits and fall within the language of s. 3 and 5 of the Act, being benefits received or enjoyed by the respondent in respect of, in the course of, or by virtue of his office or employment. I do not believe the language to be restricted to benefits that are related to the office or employment in the sense that they represent a form of remuneration for services rendered. If it is a material acquisition which confers an economic benefit on the taxpayer and does not constitute an exemption, e.g. loan or gift then it is within the all-embracing definition of s. 3.

Counsel for the respondent argues that Poynton is distinguishable from this appeal because the Funds were not obtained by the appellant as a result of his employment but were derived from a business source.

To say, as the appellant does, that the application of Poynton must be limited to theft, embezzlement, etc. between employer and employee is incorrect.

It is clear from Curlett, supra, that the application is not limited to an employer/employee relationship. The Court in Curlett found that the money was income from a business (see Curlett page 342 (D.T.C. 431)).

Three extracts from Poynton set out above bear repeating.

. . .The trial Court held that the bonus money retained by the taxpayer was income from a business venture carried on personally by him and completely separate from that carried on by the private company.

The Court in holding that the moneys constituted income in the hands of Curlett did so in the face of his defence that he was under a duty to account and that his entitlement was not absolute.

The fact that the Court stated that the money was "income from a business" indicates the scope and extent of the operation but does not affect the basic finding that money accruing in such a manner whether as the result of an isolated transaction or from a series of transactions, is taxable income.

The appellant received the money, appropriated it unto himself and used and enjoyed it for his own benefit. It was never treated by him as a loan. There was no intention to repay the Funds. Mr. Buckman was engaged in an ongoing, long term scheme to steal from his clients. In reality, he intended to old the Funds for his own account and did so in fact.

The number of misappropriations and the methods employed by the appellant had all the earmarks of a business. He took risks in stealing the Funds and being found out. His reward however, was his hope of escaping detection and keeping the Funds for his own use. There is no difference whether the thief acted as a solicitor, agent or employee. The fact that the Funds are to be treated as income flows from the realities of the situation. Paraphrasing Evans, J.A. in Poynton: What is being sought to be taxed didn't accrue to Mr. Buckman qua solicitor or qua mortgage broker but qua thief.

Mr. Buckman was engaged in a business separate and apart from his law practice and mortgage brokerage activities and what he received from this business was income. Based upon Curlett and Poynton, the Funds received were income from a business and therefore taxable. This was the reality of the situation regardless of GAAP.

Because of this finding, I need not canvass the other argument that the Funds emanated from another source.

For the above reasons the appeal is dismissed.

Appeal dismissed.