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Citation: 2005TCC78
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Date: 20050518
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Docket: 2001-967(GST)G
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BETWEEN:
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BONDFIELD CONSTRUCTION COMPANY (1983) LIMITED,
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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
Campbell J.
[1] This
is an appeal from a Goods and Services Tax (“GST”) reassessment under Part IX
of the Excise Tax Act, R.S.C. 1985, c.E-15, as amended (the “Act”),
for the period of January 10, 1991 to November 30, 1995.
[2] By
Notice of Assessment dated June 5, 1998, the Minister of National Revenue (the “Minister”)
assessed the Appellant for the period as follows:
Adjustments to GST/HST $
658,547.82
Adjustments to Input Tax
Credits 300,433.05
Total Adjustments for
Assessment Period $ 959,007.87
Penalty 417,560.26
Interest 358,564.55
Other penalty [gross
negligence] 232,510.10
Amount Owing $1,967,642.78
[3] By
Notice of Reassessment dated December 22, 2000, the Minister reversed the gross
negligence penalty of $232,510.10, and made other adjustments as follows:
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Period/Période
1991/01/10 to 1995/11/30
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Reported Amount
Montant Reporté
A
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Per Audit
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Per Appeals/Selon les appels
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Assessed
Cotisation
B
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Adjustment
Ajustement
C
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Reassessed
Nouvelle cotisation
D=(A+B+C)
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Net tax-Taxe nette
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$543,580.94
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$959,007.87
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($217,483.24)
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$1,285,105.57
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Rebates-Remboursements
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0.00
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0.00
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0.00
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0.00
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Net Interest to:
- Intérêt net au:1998/06/05
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358,564.55
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(77.26)
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$358,487.29
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Penalties to:
- Pénalités au:: 1998/06/05
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650,070.36
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(256,666.16)
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$393,404.20
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Refund Amount or Amount Owing-
Remboursement ou Montant dû
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$1,967,642.78
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($474,226.66)
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$1,493,416.12
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[4] During
the hearing the Respondent conceded that the statutory penalty and interest
should be reduced as follows (Exhibit R-2):
Statutory penalty $ 82,267.10
Interest
92,308.99
Total $174,576.09
[5] The
Appellant takes issue with the assessment of the statutory penalty and the Minister’s
disallowance of Input Tax Credits (“ITCs”). The ITCs at issue were related to invoices
where the amount owing on the invoice, including the GST, was “back-charged” to
a subcontractor. The total of the ITCs in dispute here is $153,648.88. The
Appellant also argued that the Minister was statute barred from reassessing on
GST returns respecting the period prior to June 5, 1994. If the Appellant is
successful in arguing the statute barred period, a portion of the ITCs would
also be statute barred. In other words, the Appellant takes issue with the
entire amount of back-charges reassessed at $153,648.88, a portion of which may
be statute barred.
[6] The Appellant does not disagree with the
Minister’s reassessment of the GST on PST (provincial sales tax) issue, except
to the extent that a portion may be statute barred. The Appellant submits that
the following amounts are statute barred (Exhibit A-1, Tab 11):
Under-remitted GST on sales $393,662.34
Disallowed ITCs (back-charges) $94,777.46
Evidence
[7] The
Appellant called two witnesses: Ralph Aquino, president and sole shareholder of
the Appellant; and Susan Farina, a chartered accountant and partner with
Goldfarb, Shulman, Patel & Co.
[8] The
Respondent called four witnesses: Jin Pyeon, a technical advisor with Canada
Revenue Agency (“CRA”); Chander Sudan, a chartered accountant
and partner of the accounting firms which provided advice to the Appellant;
Gail MacNeil, a team leader with the special investigations unit of CRA;
and Lisa Kelly, an appeals officer.
The Appellant’s Evidence
Ralph Aquino
[9] Ralph
Aquino was born in Italy and came to Canada in 1961 at 18
years of age. He has little formal education, having completed Grade 5 in Italy. After moving to Canada he worked in the construction industry for 13 years, learning the
business, gaining expertise in reading architectural plans, and tendering on
large projects and concrete work. In 1974, he opened his own small business
which today has grown into a company which handles approximately $300 million
dollars annually in projects. In 1991, the year the GST was introduced, the
Appellant company was doing approximately $100 million dollars in business. Today,
the Appellant employs 35 people at its head office to track projects and an
additional 15 on site in the project field. During the years 1991 to 1995, the
Appellant employed 15 employees in the office and five to six in the field.
[10] The Appellant company is an institutional builder, constructing large
buildings such as schools, hydro plants, municipal buildings and hospitals. The
Appellant itself completes the excavation and concrete work (which comprises
about 20% of each construction project) and it hires subcontractors to complete
the remainder of the project. Mr. Aquino oversees each of these complicated
projects in its entirety, but his expertise is being able to envision what a
building will look like from the documents containing the plan. In putting the
whole package together, he spends most of his time on site at the project. He
explained that a routine work day for him began very early in the morning,
organizing his employees and meeting with estimators and staff. The balance of
the day and the majority of his time is spent at the project site. His
knowledge of and expertise in this business were obtained through hands-on
experience in the first 13 years working as an employee in the industry.
[11] Mr. Aquino has had no training or knowledge respecting accounting
practices for projects of this size. He recognized this weakness and hired in‑house
staff and off-site accountants as early as 1976. In 1985, the Appellant hired a
chartered accountant named Bishwajeet Kar to act as the company’s comptroller.
In this capacity, Mr. Kar was in charge of and responsible for all accounting
matters including the accounting staff.
[12] In March 1989, the
Appellant also engaged the external accounting firm of Pannell Kerr MacGillivray
to provide audited financial statements. Mr. Aquino testified that Mr. Kar was
familiar with this firm and knew one of its representatives (Mr. Sudan) personally; and it was on Mr. Kar’s recommendation
that he chose this firm. In its engagement letter to the Appellant (Exhibit
A-1, Tab 1), the firm set out its function and responsibilities and the basis
of its anticipated fees. In the early 1990s, the Appellant paid between $25,000.00
and $30,000.00 per year in fees to the external accounting firm. Mr. Kar was
the Appellant’s principal contact with the external accounting firm. Each year an
engagement letter was written to the Appellant and Mr. Kar brought the letter
to Mr. Aquino’s attention.
[13] On July 4, 1990 (i.e. prior to the introduction of the GST on January
1, 1991), Terry Dooley, a partner at the external accounting firm, wrote to the
Appellant advising that the proposed tax would impact on the company’s
operations respecting its established accounting systems (Exhibit A-1, Tab 2).
Mr. Dooley also advised the Appellant that his accounting firm was in the
process of drafting and forwarding a GST checklist for the company’s review
which aimed to identify issues or potential problems regarding this new tax.
Without such professional help, Mr. Aquino testified he would be absolutely
unable to properly implement the new GST regime to enable his company to deal
with the tax. His view of the implementation of the new tax was that it would
be “...very messy and very complicated” (Transcript page 32).
[14] Mr. Aquino stated that through the years, the company’s comptroller,
Mr. Kar, “... became part of a family and friends” (Transcript page 31).
In 1994, Mr. Aquino gave far more responsibility to Mr. Kar in order to free
himself to care for his ailing wife who subsequently died in December of that
year. He was comfortable giving Mr. Kar the additional responsibility as they
had developed a close relationship over the years. He stated he had no reason
to doubt the expertise, competence or advice he received from Mr. Kar or from
the external accountants.
[15] Mr. Aquino testified that he took comfort
in the fact that the company had outside accountants reviewing and monitoring
his staff and their accounting activities. He explained that even if he had the
education to review the GST accounting procedures, he would still have to
depend on such people as it was too big a job in a company that did the volume
of work that the Appellant did (e.g. during the early 1990s the Appellant
paid on average half a million dollars in GST each month). Mr. Aquino testified
that he did not hire an additional external accounting firm specifically to
complete a GST compliance audit because he felt the firm he had hired would
inform the Appellant of any GST problems. Mr. Aquino went on to state:
…I cannot tell you what an accountant
should do because I don’t know, but I can tell you if somebody comes in my
office and doesn’t see that I pay enough GST, he should not come through that
door.
… If I have to hire the third person, then
I will… (Transcript page 127)
[16] The company’s audited statements were reviewed with Mr. Aquino each
year before they were filed with Revenue Canada. During the period in issue, the external accountants never indicated to
him that there were any problems with the GST procedures nor did they raise any
concerns over the internal systems that the Appellant had in place to deal with
and monitor the GST. Likewise, the company’s comptroller, Mr. Kar, never
indicated to Mr. Aquino that there was anything wrong with the company’s treatment
of the GST. Mr. Aquino also recalled that Revenue Canada’s auditors attended
the corporate premises three or four times between 1991 and 1995 to conduct
audits but never indicated that there was any problem with the treatment of GST.
Mr. Aquino’s evidence was that the Appellant’s treatment of GST was clearly
recorded in the corporate books.
[17] The Appellant’s year end is December 31. Every March, the external
accountants attended at the Appellant’s office and would take from two to three
weeks to complete the audit. The external accountants reviewed the various
ongoing construction projects and asked Mr. Aquino questions relating to the
jobs, such as percentage of work completed on a project and equipment details. In
May, the draft audits would be presented to the Appellant for review. Mr. Kar
reviewed these drafts with Mr. Aquino as Mr. Aquino did not have the expertise
to personally review them. In June, the external accountants would visit the company
premises again to review the final statement and returns with Mr. Aquino
and Mr. Kar to advise on the amount of tax that the Appellant would owe.
[18] Mr. Aquino confirmed that in June, in each of
the years from 1990 to 1994, one or two weeks prior to the date for filing and
paying tax, he and Mr. Kar met with Mr. Sudan, the representative of the
external accountants, to
review the audited financial statements. Mr. Sudan never discussed GST issues with Mr. Aquino and he never raised
the Appellant’s practice of maintaining two sets of invoices for each
transaction: one set that went to customers contained a higher GST amount than
the set of invoices that was kept in‑house. Mr. Aquino testified that he
did not know, and could not have known, that Mr. Kar maintained two sets of
invoices because he was unable to go into a computer to check the books. He
knew nothing about bookkeeping and hired external accountants as an additional
check on his business to ensure everything was done within the law.
[19] Mr. Aquino gave evidence that at no time during these meetings, or at
any other time, did anyone bring to his attention any issues or problems
respecting the manner in which the Appellant dealt with GST. Throughout the
years in question, there was no indication from either the external accountants
or Mr. Kar that there might be difficulties with the Appellant’s GST reporting.
[20] Mr. Aquino confirmed that he did not ask the
company’s comptroller, Mr. Kar, for information regarding the financial
statements or discuss the GST filings because “...the education I have I couldn’t
help him in the accounting” (Transcript page 92). If Mr. Kar asked Mr. Aquino
anything respecting the GST filings, Mr. Aquino simply told Mr. Kar to make
sure it was done properly and within the law and that if he had to employ
someone else to assist him then he should do so. He gave Mr. Kar wide authority
to do his job of maintaining the corporate books and records.
[21] Mr. Aquino never went through the
GST documentation himself to ascertain whether GST was being properly collected,
reported and remitted or if ITCs were being properly claimed. He stated that
even if he had had the time to go over the massive amount of bookkeeping, given
his lack of formal education, he would have been incapable of reviewing and
understanding the accountants’ work.
[22] Mr. Aquino was unaware of any problems until
Mr. Kar’s employment was terminated in late November 1995, when he was caught
removing a box of documents from the head office. This was in the year
following his wife’s illness and death in 1994, during which time Mr. Aquino had
delegated additional authority to Mr. Kar.
[23] Grant Dickinson, who replaced Mr. Kar in
mid-December 1995, discovered the GST filing problems and brought them to Mr. Aquino’s
attention by mid‑January 1996. Mr. Aquino advised him to rectify the
problems immediately that same month. He stated he was “… really shocked, by
having all those people around me” (Transcript page 44) and yet no one ever
informed him there could be a problem. In addition to the GST reporting
problems, Mr. Dickinson informed him that the corporate records disclosed that Mr.
Kar had defrauded the Appellant of $940,000.00. At the suggestion of his
lawyer, the Appellant hired a forensic accounting firm to investigate. The
investigative report, which cost the Appellant a further $150,000.00 (Exhibit
A-2), resulted in the eventual conviction of Mr. Kar for defrauding the
Appellant; however, no restitution was ever paid to the Appellant.
[24] On June 5, 1998, the Appellant was
reassessed in the amount of $1,967,642.78 and on June 19, 1998, the Appellant
issued a cheque for payment of this amount. Although he almost lost his company,
he testified that he instructed that this payment be made immediately upon
reassessment because he did not want any further problems.
[25] The Appellant
subsequently replaced its external
accountants, initially with the accounting firm of Ernst & Young, and
eventually with the firm of Goldfarb, Shulman, Patel & Co.
The Evidence of Susan Farina
[26] Susan Farina is a partner at the firm Goldfarb,
Shulman, Patel & Co., the Appellant’s current external accountants. She
testified that her firm completes the Appellant’s corporate returns and provides
the Appellant with audited financial statements and advisory services. As a
part of the auditing process, the firm reviews a client’s GST compliance to
ensure the financial statements are free of material misstatements.
[27] Ms. Farina explained that an accountant can
be employed to draft financial statements at three different levels. The
highest level of involvement (and most expensive) is to be engaged as an
auditor. At this level, an auditor
...examines the evidence underlying the amounts
in the financial statements, as well as the disclosures in the notes to the
financial statements. The auditor considers the appropriateness of the
accounting principles used and the overall presentation of the financial
statement. At the conclusion of the engagement, assuming the auditor has no
reservation, the auditor expresses that in its opinion the financial
statements, in all material respects, are free from misstatement and are in
conformance with generally accepted accounting principles. (Transcript page
151)
Ms. Farina’s firm is currently engaged with the Appellant
at this highest level. Similarly,
during the period at issue in this appeal, the external accounting firm (Pannell Kerr
MacGillivray) was appointed by
the Appellant to provide a full audit. While many corporations of the Appellant’s size use this audit level,
there are many others that use the second highest level of engagement (the
review level) and still others that use the lowest level.
[28] Ms. Farina explained the measures her firm undertakes with respect
to GST when engaged at the highest level. To ensure the appropriate systems are
in place and that there is compliance, a questionnaire is completed. This
questionnaire addresses specific areas, where concerns could arise, and identifies
on a month‑to‑month basis the figures reported on the GST returns,
in particular, the sales, GST collected and ITC amounts reported. Total sales as
reported on the GST returns are then compared to total sales in the corporate
records, and where necessary, adjustments are made. She explained that these
types of activities are not specifically documented in the audit engagement
letter to the clients. Rather, the letter simply indicates that in making
inquiries, the firm will have access to the clients’ records and staff. Ms.
Farina stated that the number of accounting staff employed by the Appellant
during the relevant period was very similar to the number it presently employs.
[29] Ms. Farina outlined the steps the Appellant
takes to ensure compliance with the law in operating its business. Firstly, the
Appellant employs a comptroller to supervise its in-house accounting staff and
oversee the entire accounting operation, including the filing of the monthly
GST returns. The comptroller acts as a liaison between the Appellant and the
external auditors and is the main contact person in the company during the
audit process. To the best of her knowledge, Mr. Kar, the company’s comptroller
during the relevant period, had an educational background and industry
experience comparable to the individuals hired by the Appellant after he was
fired. Secondly, the Appellant maintained a premier accounting software system
and employed accounting procedures used by similar general contracting companies.
This system and the procedures the Appellant utilized were in her words:
…designed to ensure that all of the
information that’s relevant to the computation and compliance with the GST
rules is captured within the books and records of the corporation. (Transcript
page 165)
Finally, the company hired reputable external auditors
to provide an additional level of comfort that the internal accounting
activities were being appropriately applied.
[30] In addition, Ms.
Farina said that the Appellant
has always been co-operative and receptive to suggestions for changes to its
system. She pointed out that some of the changes her firm recommended, when they
took over the account, cost the Appellant additional money to implement.
[31] Ms. Farina reviewed the figures on both the
assessment of June 8, 1998 and the adjustments made on the reassessment of
December 22, 2000 (Exhibit A-1, Tab 9 – CRA working papers for the
reassessment). In addition to penalties and interest, she identified the issues
as being related to the treatment of GST, where there was a “back-charge”, and
to the calculation of GST on PST.
[32] Ms. Farina outlined the procedure where the
problems with GST arose in applying back-charges. In any project, the Appellant
hired subcontractors to complete about 80% of the work. Sometimes a
subcontractor’s work was deficient. If this subcontractor was unable or
unwilling to rectify his work then the Appellant would engage a second subcontractor
to remedy the work and this second subcontractor would invoice the Appellant. Ms.
Farina gave the example of a drywall subcontractor who causes damage to the
electrical work: since the drywall subcontractor has no expertise in rectifying
electrical problems, a second electrical contractor is called in to correct the
work. In circumstances such as these, it was the Appellant’s practice to claim
ITCs on the amount payable to the original subcontractor for the drywall work
and also on the amount payable to the second subcontractor for the remedial
electrical work.
[33] The Appellant’s accounting department would
then record a “back-charge”, in the sub-ledger kept for the original subcontractor,
equal to the amount of the invoice (including the GST). The result of the
back-charge was a reduction in the amount the Appellant would pay the original subcontractor.
The accounting department would then forward the invoice along with a letter to
the original subcontractor. This letter notified the subcontractor of the
back-charge and requested that the subcontractor issue a credit note equal to
the amount of the invoice (including the GST).
[34] The original subcontractor could either
challenge the back-charge or accept it. If it is challenged successfully, the
back-charge is reversed, the Appellant remains liable for the invoice and no
GST issue arises with respect
to the Appellant claiming the ITCs on that invoice. It is where the original
subcontractor accepts the back-charge that the GST issue arises. Ms. Farina referred to the example at Exhibit
A-1, Tab 15 and explained the procedure, followed by the Appellant, as follows:
The example under Tab 15 is a
situation where a back‑charge was raised and was not reversed. So the
procedure is that the project manager requests that the accounting department
prepare the back‑charge notification. The project manager signs the back‑charge
notification. The accounting department assigns a number to the back-charge,
which is typically prefaced with B/C, denoting back-charge and then before
sending the back-charge notification out to the subcontractor, the accounting
department records the back-charge in the sub-ledger for the particular
subcontractor.
Now the sub-ledger is the
document within Bondfield's books and records that tracks the contract with the
subcontractor. It starts out by indicating the total contract amount. It keeps
track of the payments made against the contract amount. In a separate section
it keeps track of the back-charges, and then the total amount to be –-
remaining to be paid under the contract. (Transcript page 186)
[35] In Ms. Farina’s review of the audit working
papers and other corporate documents, she found no evidence to suggest that any
subcontractor ever issued a credit note in respect of any back-charge; and, apart
from the letter of notification, there was no other document purporting to be a
debit note. The December 22,
2000 Notice of Decision (Exhibit A-1, Tab 7) referred to these notification
letters as debit notes, however Ms. Farina testified that they were not debit
notes for several reasons. Firstly, the letters clearly indicated that they
were simply a request to start discussions on back-charges. It is plain, she
noted, from the document that the Appellant was prepared to discuss and perhaps
reverse the notification of the back‑charge. Secondly, the documents were
in letter format and were not referred to as debit notes. Under general
accounting principles, she would not classify these notification letters as
debit notes for the purposes of GST. Finally, in order to be viewed as a debit
note – upon which the recipient and supplier could adjust GST pursuant to
subsection 232(3) of the Act – the letter must contain certain
prescribed information, and these letters did not contain that information.
[36] Ms. Farina reviewed the second issue
respecting the calculation of GST on PST. To understand this issue, she
provided an overview of how
payment requests are generated in the construction industry. A contractor such
as the Appellant does not produce the invoice. Rather, they are produced by the
architect or engineer for the customer. The process is instituted when the general
contractor (the Appellant here) on the last day of each month sends an
application for payment or progress billing to the customer’s architect or
engineer. The architect or engineer inspects the progress of the project and,
if satisfied, prepares a progress certificate (certificate of payment),
certifying the approved amount of billing. Both the application for payment and
the progress certificate (certificate of payment) include GST on the full contract
price for the particular month. The contract price includes amounts paid for
both labour and construction materials. Since the construction materials would
have been subjected to PST, by charging GST on the whole contract price, GST was
being charged on an inherent amount of PST.
[37] The Appellant’s comptroller, Mr. Kar,
devised a calculation or a formula by which GST would be adjusted in such
instances. He estimated that approximately 37% of the contract revenue related
to construction materials and that this 37% included PST. The accounting
department would divide the 37% amount by 1.08 (to arrive at the cost before
PST) and then multiply the quotient by 8% in order to determine the amount of
the PST applicable to the
construction materials. The result of applying this formula was
that 2.7407% of all revenue was assumed to be PST on materials. To illustrate,
consider the following example:
$10,000.00 contract revenue before GST
$3,700.00 assumed to be related to
construction materials ($10,000.00 x 37%)
$3,425.93 cost of construction materials
before PST ($3,700.00 ÷ 1.08)
$274.07 PST on the construction materials
($3,425.90 x 8%)
[38] During the period in issue, the Appellant
used this formula to reduce the amount of GST collected. Mr. Kar took the
position that GST respecting the PST amount did not need to be remitted. This
formula was used between January 1, 1991 and November 30, 1995 and terminated in December 1995, very
shortly after Mr. Kar left the Appellant’s employment.
[39] The GST on PST was deleted by the Appellant’s
accounting department by producing a worksheet for each progress billing. The
original copies of these working papers were attached to each GST return for
the month in question. Ms. Farina distinguished these working papers from
invoices. Where an invoice should contain customer address information, the
working papers did not contain such information; and where invoices should add
PST and GST to the sales amount, the working papers used the PST to reduce the sales
and GST amounts. These working papers were used to calculate the Appellant’s
GST reduction which led to the under-remittance of GST.
[40] In Ms. Farina’s opinion, the method
employed in these working papers was open and obvious. She referred to an
invoice register (Exhibit R-1, Tab 5), for December 1993, where the Appellant
summarized its progress billings for a particular month, setting out the sales
amount, hold back amount, GST amount, and net accounts receivable. The GST
amount on every progress certificate was always different than the GST amount
on the sales register. From her perspective this method, used on each and every
occasion, was open and obvious because:
... the invoice in any general contractor
situation is the certificate that’s issued by the customer’s architect or
engineer. Each and every billing amount on those progress certificates reflect
a different amount than the GST that’s reflected in the invoice register. If
somebody was trying to conceal the method of accounting for GST, the alternative
way to have accounted for this would have been to have recorded each and every
sales invoice based on the architect’s or engineer’s certificate, do a
worksheet dealing with all of the billings for the particular month and making
one adjustment in respect of the GST on PST on all of the invoices, so that
anybody doing a sample check of one -- of several progress certificates would
be able to track them into the invoice register without exception. (Transcript
page 207)
and at page 208 of the Transcript she states:
... So anybody looking at the invoice
register and performing a very simple reasonability test would notice right
away that the GST was not 7 per cent of the sales amount minus the hold-back
which is what one would expect it to be.
... if any attempt was being made to
conceal this issue, it would have been possible for the adjustment that we
referred to not be recorded as additional revenue but to be set up in a
liability account and just simply not paid.
[41] Ms. Farina referred to Exhibit A-1, Tab 12
which contained summaries of each GST return, for each month filed by the
Appellant, throughout the audit period. These summaries showed that the amounts
reported for sales and other revenue were consistent with the amounts in the
Appellant’s sales register, with the exception of the GST amounts. The sales
register would be approximately 2.7407% lower, reflecting the formula’s application
versus simply deducting 7% of the sales amount.
[42] Ms. Farina reviewed the audit working
papers of the external accounting firm for the years 1991, 1992, 1993 and 1994
(Exhibit A-3). In looking at the verification processes used in each year, she
confirmed that the procedures used were basically the same procedures that her
firm presently employs on behalf of the Appellant. In addition, she reviewed
the reasonability test, respecting GST reporting, employed in these working
papers; the interim audit review checklist, which assists in doing an audit;
and the management letter prepared at the end of an audit. Counsel referred Ms. Farina to a
handwritten note prepared by the Appellant’s accounting department (part of Exhibit
A-3, Tab 2) dated December 31, 1992. This note referred to the 2.7407%
reduction respecting GST and a reference to PST being approximately 37% of the
total contract. Accompanying these notes in each year were working papers of the
Appellant which recounted total sales and how the formula was used to reduce
the tax. She testified that if the information contained in these notes and
papers (which indicated an incorrect treatment of GST) raised a concern in her
mind, there were procedures she would take to deal with the issue during the
audit conducted for the Appellant, particularly if it had significant tax
implications.
[43] Counsel also took Ms. Farina through the
significant matters memo and the interim audit review checklists of the
external accounting firm but none of these documents contained any reference to
the use of the formula respecting GST on PST or treatment of the GST tax. On
the summary of the firm’s audit statements, the reference to commodity tax was
marked as “low”, which Ms. Farina stated meant that the external auditors were
evaluating the risk for that particular client, with its treatment of tax, as
low.
[44] Ms. Farina noted that there were references
in the auditors’ notes specifically identifying the formula devised by Mr. Kar,
together with a note which stated: “Client collects GST on PST but doesn’t
remit it”; nevertheless, the 1993 audit checklist made no reference to GST
problems. Three issues for discussion with Mr. Aquino were identified in a
handwritten note dated December 30, 1993. The first two items did not deal with
GST. The third item, while GST related, dealt merely with a deduction for GST that
the Appellant had taken on the entire cost of a vehicle, which was beyond the
maximum allowable limit. No other GST issues, particularly the GST on PST issue,
were identified in this handwritten note; yet, Ms. Farina noted, the auditors
felt the vehicle issue was significant enough to be identified for discussion and
remedy with Mr. Aquino.
[45] The working papers in 1993 are similar to
1992. There is again a reasonability list utilized, which compares the GST
collected, by multiplying total revenue by 7% and comparing this figure to the
GST amount on the client’s records. The difference in 1993 was indicated to be “past
trivial”.
[46] For the 1994 reporting period, there was
still no reference to GST problems in the year-end audit review checklist. The
handwritten auditor’s notes raise five issues under “Points for Discussion with
Mr. Kar” but none of these related to the GST problems. The significant matters
memo for 1994 appeared to make the first reference to keeping two sets of GST
documents, one for customers to pay and one to record GST collected on
sales. This memo contained handwritten notes at its conclusion, including a
reference to discussions with Mr. Kar and Mr. Aquino during their meeting in
June 1995.
[47] On cross-examination, Ms. Farina did agree
that the reasonability list is a list that looks at numbers including GST to
see if the figures appear reasonable. However, it is not a detailed review. She
also confirmed that the three different levels of accounting review, referred
to in her direct examination, were in respect to the financial statements and
not the GST filings. Ms. Farina stated that the objective of her firm at the
audit level is to ensure that the financial statements are free of material
misstatement and that they fairly represent the financial position and
operations of the corporation.
[48] On further cross-examination,
Ms. Farina confirmed that she formed her conclusions,
respecting Mr. Kar’s development of and use of the GST on PST formula, based on
CRA audit staff notes, external auditor’s working papers and conversations with
the Appellant’s present comptroller. She agreed with Respondent counsel that it
was based on her deductions after reviewing these various sources, rather than
actual knowledge, because she was not engaged as the Appellant’s external
auditor during the period in issue. Ms. Farina also agreed that she was not a
member of the Appellant’s external accounting firm that was employed during the
period in question and as such had no actual knowledge about the preparation of
that firm’s working papers which she reviewed in direct examination.
[49] Respondent counsel also reviewed Ms. Farina’s
conclusion that the Appellant’s GST recordings were done in an open and obvious
manner. Ms. Farina confirmed that the sales figures reported on the GST returns
agreed with the sales figures in the sales journal and that no adjustments were
made in an attempt to conceal the fact that a portion of sales were calculated using
Mr. Kar’s formula. Ms. Farina did not agree with Respondent counsel’s
suggestion that it would be open and obvious only if one had access to both
sets of documents because on its face, the GST return does not state that the
GST billed was an amount slightly higher than the amount recorded on the
return. Ms. Farina stated that, in her opinion, it was open and obvious because
there was no attempt to alter information respecting reported sales. Ms. Farina
also disagreed with the Respondent counsel’s suggestion that to determine that the
GST amount reported was slightly less, one would have to look at source
documents and internal records. Ms. Farina stated that if the holdback amount
was subtracted from the sales amount and then the resulting amount multiplied
by 7%, it was evident that the result would be higher than the entry on the
report.
Respondent’s Evidence
The Evidence of Jin Pyeon
[50] Mr. Pyeon was an auditor for large GST files
during the appeal period. He became involved in the Appellant’s file in 1996,
focusing on the area of ITCs only. Mr. Pyeon explained that when the Appellant
employed a second subcontractor to remedy deficient work, the Appellant did not
adjust for the GST reimbursed on either the original contract for work
performed or the remedial work contract completed by the second subcontractor.
He concluded that the Appellant over claimed ITCs in respect to the
reimbursement of GST to the Appellant. Mr. Pyeon reviewed the documents
(Exhibit R-1) relating to these back-charges, where he found evidence that ITCs
were claimed for all of the GST charged by both subcontractors. He explained
that his review included not only the sub-trade ledgers but also other
documents such as the purchase journal, the general ledger GST account and the
cash disbursement journal.
[51] In assessing the Appellant beyond the
statutory limitation period for the period January 1, 1991 to June 5, 1994, Mr.
Pyeon explained why the CRA determined that the Appellant made
misrepresentations with respect to these back‑charges. In making the
determination he considered a variety of circumstantial factors including the
following: the Appellant retained a professional accountant on staff, their
accounting system was sophisticated enough to catch almost all of the numerous
transactions, the accounting report made everyone in the company aware of what
was happening within the company, it had external accountants, the amount was
substantial and the Appellant was reimbursed for the amounts (including GST) owed
to those subcontractors that completed remedial work.
[52] On cross-examination, Mr. Pyeon admitted
that it was prudent for the Appellant to have such professional staff in its
employment, that the Appellant had in fact a very professional accounting staff
that was sufficiently large for the size of the company, that the company had a
premier computer system throughout the audit period, that outside accountants
were also engaged to provide audited financial statements and that for the most
part, as noted in a memo in the working papers, the Appellant’s officers were co-operative.
Mr. Pyeon felt it would be reasonable and prudent for the Appellant to rely on
its accounting firm. He also agreed that the Appellant’s method of dealing with
ITCs was consistent and that it did not try to suggest in the records that ITCs
had been adjusted. Mr. Pyeon agreed on further questioning that the basis of
assessing the Appellant for back-charges was based on the fact that it did not
make the appropriate GST adjustments. When asked if this decision was based on
section 232 of the Act, Mr. Pyeon responded:
Not the Section 232 we relied on. We relied
on Section 169, entitlement to the ITC. Not 232, but 169… (Transcript page 441)
Mr. Pyeon acknowledged that section 232 deals with the
issuance of debit notes but that it was not section 232 which he used to assess
the Appellant. He did not know if section 232 was used in the reassessment of
December 2000. Mr. Pyeon agreed with counsel’s suggestion on cross-examination
that it would not be a misrepresentation if an individual took the legitimate
view that section 232 applied instead of another section of the Act.
[53] Although there are three types of credit
return audits, he stated that on those audits where auditors attend at a taxpayer’s
premises, as they had done in this case, he would expect that auditors would
review the ITCs and, in so doing, would review the back‑charges. He was
not aware that the CRA had completed several such audits respecting this
Appellant prior to 1996. He also admitted that he would not expect the
President of a company the size of the Appellant to be involved in the “nitty-gritty”,
as he put it, (Transcript page 456) of the operations.
The Evidence of Chander Sudan
[54] Mr. Sudan is currently a partner with the accounting firm Martyn,
Dooley & Partners (“Martyn, Dooley”). He was working with the firm Pannell
Kerr MacGillivray in 1987 or 1988 when that firm was hired by the Appellant to
be its external accountants. Pannell Kerr MacGillivray merged with
Doane Raymond (to become Doane Raymond Pannell) and later with Martyn,
Dooley. Throughout these changes, the Appellant remained their client and they
were employed to audit the corporate financial statements. He acknowledged that
the Appellant terminated the services of Martyn, Dooley in early 1996. Mr. Sudan worked in the income tax department of the firm and
acted as a contact partner. Each year he took the financial statements and
accompanying documents to the Appellant’s office to discuss them with Mr. Kar
and Mr. Aquino. Some time later he would have the tax returns signed. Mr. Sudan’s primary contact person at the Appellant’s office
was Mr. Kar. Mr. Kar always attended any meetings where Mr. Aquino was present,
and occasionally Mr. Sudan would also meet with Mr. Kar alone.
[55] Mr. Sudan was not aware of any advice given by his firm to the
Appellant concerning GST. He did not know if the Appellant had asked his firm
to do a GST compliance audit, but recalled that the Appellant requested a quote
on an internal audit in 1994. However this was never done. Mr. Sudan thought that this audit request was made during the
meeting for the 1993 reporting year in June 1994 after Martyn, Dooley pointed
out to Mr. Aquino improperly claimed GST as it related to a vehicle.
[56] Mr. Sudan did not complete the Appellant’s actual audit. Rather, it
was the firm’s audit manager for the Appellant’s file, Karen Prapavessis. After
Ms. Prapavessis produced the audit working papers each year, they were
reviewed by the firm’s audit partner, Terry Dooley. Although Mr. Sudan never personally reviewed these working papers, as
the contact partner for his firm, he always met with Mr. Kar and Mr. Aquino
during the last week of June to review the final statements and returns. All of
the audit files including the working papers, financial statements and
corporate returns accompanied him to the Appellant’s offices. Even though Mr. Sudan never reviewed the working papers, he took them
with him to these meetings so he could refer to them if he was asked a question.
Included in the working papers were all the related documents, such as the
engagement checklist and the significant matters memo. The only document he
actually reviewed was this significant matters memo, together with the
financial statements, so that he could discuss them with Mr. Kar and Mr. Aquino.
On cross-examination, Mr. Sudan clarified that he took the firm’s
working papers to his meetings with Mr. Kar and Mr. Aquino to assist him in
giving information to the client respecting the financial statements, but that
he did not review the audit checklist with the client during these meetings.
[57] Mr. Sudan stated that although he was the contact person for his firm,
he did not educate himself on GST matters. He pointed out that the firm had a
separate GST department to which he deferred. He agreed with Appellant counsel’s
suggestion that he did not know much about GST.
[58] On cross-examination, Appellant counsel took Mr. Sudan through each year of the firm’s working papers to
determine if the firm raised any issues with the manner in which the Appellant
calculated GST after removing PST. Although Mr. Sudan acknowledged that the working papers contained references to the
Appellant utilizing a formula to remove PST before calculating GST, his
response generally was to the effect that he had not reviewed these documents
and that he had no knowledge of the GST issue until June 1995. He confirmed
that unless a problem was raised in the significant matters memo he would not
discuss it with Mr. Kar or Mr. Aquino. Mr. Sudan agreed that none of the significant matters memos in the years preceding 1994
raised or made any reference to a problem respecting the GST formulation, even
though the accountants in their working papers were describing the system of
calculating GST after removing PST and actually making the calculation based on
the formula.
[59] The 1993 working papers contained a document entitled “audit program
commodity taxes”. Mr. Sudan confirmed that this document did not
raise any GST problems or question the appropriateness of how GST had been
charged on taxable sales and revenues. Mr. Sudan acknowledged the statement on this document that concluded: “I am
satisfied that the results of the above procedures provide reasonable assurance
that commodity taxes are not materially misstated”. The next document Mr. Sudan reviewed was the reconciliation schedule. He agreed
that the formula was again referenced and recognized by the external
accountants but that no problems were noted. Counsel attempted to have Mr. Sudan go through the calculations contained in these
papers but Mr. Sudan was simply unable to follow the
calculations or adjustments completed by his firm. Counsel also referred Mr.
Sudan to a letter on the Appellant’s letterhead (Exhibit A-3, Tab 3) concerning
the Municipality of Muskoka which contained a handwritten note referencing that the GST remittance
was reduced by a PST portion. Mr. Sudan again agreed
that Martyn, Dooley had fully recognized the collection procedures that the
Appellant had employed in not remitting GST on the PST.
[60] Appellant counsel then took Mr. Sudan through the 1994 working papers
(Exhibit A-3, Tab 4), which he discussed with Mr. Kar and Mr. Aquino during
their June 1995 meeting. Mr. Sudan acknowledged that the audit checklist did not
identify any contentious accounting audit problems. Counsel also referred Mr. Sudan to a handwritten memo
entitled “Points for Discussion with Mr. Kar”; Mr. Sudan agreed that the only problem referenced here was a
query as to whether Mr. Aquino had a will. As well, counsel referred Mr. Sudan to an earlier letter dated
July 8, 1992, which was included in the 1994 working papers. In this letter,
Mr. Sudan wrote to Mr. Kar
advising him of a potential problem concerning withholding taxes in 1992 that
might expose the Appellant to liability. Mr. Sudan testified he did not know what prompted him to write this letter:
that is, whether he recognized the problem himself and wrote the letter or if
the Appellant requested that he write it. He also testified that he was not
sure whether he would write a letter similar to this to notify the Appellant of
a problem of a much more serious nature, such as the problem that is at the
centre of this appeal.
[61] Appellant counsel
then reviewed the 1994 significant matters memo with Mr. Sudan. This significant matters memo, for the first time,
contained references with respect to commodity taxes: that the procedures were
“consistent with last year” and that the Appellant maintained two sets of
invoices. Although the system of calculating GST after removing PST had been
described by the accountants in their working papers, this was the first time
the issue was referred to in the significant matters memo. Mr. Sudan could not explain why this issue was not brought to
the Appellant’s attention in a letter as other matters had been. The 1994 significant
matters memo contained a further reference, under items to be discussed with
Mr. Aquino, to an issue with respect to a GST deduction related to a
shareholder acquired vehicle. Mr. Sudan did not know why
the more serious GST issue referenced under the heading “Commodity Taxes” was
not listed for discussion with the Appellant except that when he discussed it
with Mr. Aquino he thought this might be sufficient communication to the
Appellant. He did agree that he never advised Mr. Aquino of the consequences of
this issue – just simply that he advised that it was a problem that should be
fixed. He did no further follow-up with the Appellant.
[62] On direct
examination, Respondent counsel had referred Mr. Sudan to the 1994 significant matters memo (which was also contained in Exhibit
R-1, Tab 11). Under the heading “Commodity Taxes” on page one, the
significant matters memo states:
Consistent with last
year – client maintains two sets of invoices
one for customers to pay
and one to record GST
collected on sales
the difference between the two – is on the
invoice for GST remittance purposes, break down the PST portion included in the
sales, so that the GST amount is less – the excess GST collected is recorded by
the client as miscellaneous revenue
Mr. Sudan testified that he was not aware of this
issue before the June 1995 meeting. He stated that he raised the point with Mr.
Kar and Mr. Aquino and advised them that they were collecting GST on PST but
not remitting it and that it should be remitted; he said he thought Mr. Kar or
Mr. Aquino said they would fix it. He was not aware of anything that his firm
did after that to address or correct this matter.
[63] Mr. Sudan testified that the significant matters memo would
have been prepared by Ms. Prapavessis and reviewed by Mr. Dooley. In addition
to the typed text, several handwritten notes appeared on pages one and two of
the memo. Mr. Sudan identified one of the handwritten notes
on page two (the one entitled “Related Party Disclosure”) as belonging to Ms.
Prapavessis and the remaining notes as belonging to Mr. Dooley.
[64] On cross-examination, Appellant counsel referred Mr. Sudan to the handwritten notes beside the heading
“Commodity Taxes” on page one, which read:
What?
not Kosher
Mr. Sudan identified this writing as belonging
to Mr. Dooley. He stated that the letter N which was circled meant that “the
explanation was on the next page”. The second page of the memo contained Mr.
Dooley’s handwritten explanation of the three word note on page one. The
portion of the explanation that Mr. Sudan was able to decipher read:
checked with KP [Karen Prapavessis]
this discussed with Kar
and Ralph [Mr. Aquino]
both aware of these …
[65] On direct
examination by Respondent counsel, Mr. Sudan had initially stated that the handwritten notes were not on the document
at the time of the June 1995 meeting. On further questioning he clarified
that the notes written by Mr. Dooley were not present at the time of this
meeting, but he was not sure whether the note written by Ms. Prapavessis
(which is not relevant to the issues in this case) was present at that time. On
cross-examination by Appellant counsel, Mr. Sudan testified that Mr. Dooley’s
handwritten notes on page 2 (the explanation) were definitely not present at
the time of the meeting but that Mr. Dooley’s note on page one (“What? not
Kosher”) was “probably” present (Transcript page 529). He explained that Mr.
Dooley’s handwritten note, “What? not Kosher”, could have been on the
significant matters memo when he took it to this meeting because Mr. Dooley had
to make an evaluation of materiality before the statements were issued.
However, on further questioning by Appellant counsel,
Mr. Sudan admitted that he was
just guessing; that he was not sure whether the note, “What? not Kosher”, was
present at the time of the meeting. At Transcript page 534, Appellant counsel
asked Mr. Sudan:
...You’re certain that that was there?
and he responded:
I said it looks to me this was – this may have been there.
I’m not sure.
...
Well, I don’t remember if it was there or not, so I
don’t know. I’m guessing it was.
The Evidence of Gail MacNeil
[66] Ms. MacNeil, a team leader with the CRA investigations, focused her
review on how the Appellant calculated and remitted GST. She became involved
when the file was referred from audit to investigations in May 1996. According
to Ms. MacNeil, the problem was that on the invoices provided to the
auditor, the consideration for a particular progress billing had been reduced by
2.7407%, which was allegedly for PST buried in the invoice, before applying the
7% GST.
[67] In completing her work for the years 1991 to 1993, she did not review
every source document because she did not have all the records for those years.
Instead, she used an arithmetical calculation based on the general ledgers and
the sales ledgers. However, for 1994 and 1995 she was able to review all of the
source documents for each transaction. She testified that for both 1994 and
1995 she conducted third party checks whereby each sales invoice received by
the third party was compared to the sales invoice that was kept by the
Appellant and provided to the auditors. This third party check by Ms. MacNeil
revealed that the GST on the customers’ invoices had been calculated on the
full consideration of the contract. In contrast, on the invoices provided to
the auditor, the consideration had been reduced by 2.7407% before the GST was
calculated. The result was that a higher amount of GST was charged to, and paid
by, the customer than was remitted by the Appellant.
[68] Ms. MacNeil stated that the invoices, containing the lower amounts of
GST, were seized in binders labeled “GST 94” and “GST 95” and that invoices
identical to those provided to the customers were also located on the premises.
She referred to Exhibit R-1, Tab 4, which was a spreadsheet she prepared of the
invoices completed by the Appellant in respect to one project that contained
six progress billings or invoices. She reviewed a set of documents, including the
architect’s certificate of payment, which is provided to the customer, advising
that a certain amount is owing to the Appellant; the sales invoice or progress
billing that is sent from the Appellant to the customer; and a cheque from the
customer to the Appellant. All three documents show the same amount of GST. The
final document in the set was the invoice provided to the auditors but never
given to the customer. This last document contained the same total sales price as
the first three documents, but it was subjected to a lesser amount of GST. She
stated this was typical of every transaction she reviewed. The difference
between the amount of GST on the customer invoices and the invoices provided to
the auditors established the basis for the assessment.
[69] She decided that in the circumstances of the case, the Appellant
should be assessed beyond the statutory limitation period because the GST
amounts were substantial and because the company had an internal auditor
...who stated that he did it
knowingly and because if he’s guilty of doing this so therefore is the company,
... and he didn’t inform the auditors of the two different sales invoices ...
And Bondfield had two individuals from CCRA go to their business premises and
explain GST, and no one questioned if the method was correct. And no one at
Bondfield questioned if it should be done this way or a different way.
(Transcript pages 658-659)
[70] On cross-examination, Ms. MacNeil was referred to a memorandum from the
audit notes (Exhibit A-4) which indicated that all sales and purchase invoices
were provided to the auditors on request on the occasions during this period
when they visited the Appellant’s premises. In this memo the auditor indicated that
there was a 2.7407% deduction for PST from the contracts before calculating GST
and that the contracts which showed the removal of the PST from the sale price
were also being provided to the auditor.
[71] Ms. MacNeil stated that, in her opinion, she would characterize the
application for payment to a payment certifier in the construction industry as
an invoice that would attract GST.
[72] She stated that the Appellant recorded all of its transactions in the
general ledger and the sales ledger.
[73] She agreed that the system was changed as soon as a new internal
auditor, Mr. Dickinson, was hired in December 1995. She recalled that an
individual with the Appellant informed her that the GST on PST system was
developed by Mr. Kar, its internal auditor at the time, and that most of
the GST returns were signed by him.
[74] Ms. MacNeil confirmed that she attended at the Martyn, Dooley offices
and that she took certified copies of their working papers (Exhibit A-3).
Appellant counsel referred Ms. MacNeil to the handwritten notes dated December
31, 1992 (Tab 2 at page 32), which set out in detail how the GST on PST was
being calculated. It was her understanding that the difference between the GST
on the progress certificate and the GST calculated by the Appellant was added
to the Appellant’s income. From her review of the documents of Martyn, Dooley and
her discussions with them, she determined that Martyn, Dooley was aware that
this amount was being added to the Appellant’s income. She stated that Martyn,
Dooley advised her that they had informed Mr. Aquino and Mr. Kar that the
method used for calculating GST on PST was incorrect. Ms. MacNeil thought that
Martyn, Dooley gave her this information around the time that the Appellant sued
Martyn, Dooley for what had occurred.
[75] She confirmed that there was no indication in any of the documents
contained in the extract from the CRA auditor’s contact and review file folder
(Exhibit A-5) that the CRA auditor, Phil Soosaithasan, did not receive the
Appellant’s co-operation when he requested documents.
[76] Ms. MacNeil stated that she used subsection 298(4) to assess beyond
the statutory limitation period because:
1) the amount was
significant as it totalled over $600,000.00;
2) the Appellant
employed an internal accountant (Mr. Kar) for the period of the assessments;
3) the internal
accountant stated that he knowingly did not adjust GST on back-charges and
adjusted GST on PST;
4) the internal
accountant made a misrepresentation attributable to negligence, carelessness or
wilful default and therefore the Appellant has misrepresented these amounts;
5) Mr. Dickinson, the
internal accountant hired to replace Mr. Kar, did not inform the auditors of
the two different sales invoices when the auditors attended at the Appellant’s
offices in January 1996 and was therefore not co-operative;
6) there were two
different and completely separate sales invoices, those shown to the auditors
and the invoices issued to the third parties and this second set to the third
parties was not shown to the auditors; and
7) two individuals
from the CRA attended at the Appellant’s premises to explain GST and no one
questioned the CRA officials as to whether the method used by the Appellant was
correct.
[77] Ms. MacNeil agreed on cross-examination that there was nothing in Mr. Soosaithasan’s
notes, from his meetings with Mr. Dickinson, that would indicate that Mr. Dickinson
did not inform the CRA auditor of the two sets of sales invoices or show the CRA
auditor those invoices. She stated she was not aware that Mr. Dickinson was at
this time also dealing with a million dollar fraud perpetrated against the
Appellant by Mr. Kar, which he had just discovered. She admitted that she relied
on Mr. Kar for information as to what the Appellant was doing with respect to
the issues. She agreed on cross-examination that she relied on Mr. Kar’s
honesty and the accuracy of his statements to her with respect to gathering
information on the issues. Although she knew he had been dismissed from employment
with the Appellant, she did not recall if he had been charged with fraud at that
time. She did not consider this relevant to her investigations.
[78] On further cross-examination, Ms. MacNeil also agreed that the
Appellant kept all of the payment certificates and progress certificates in its
files and that to the best of her knowledge kept adequate and complete books
and records. She also agreed that the Appellant dealt with the GST on PST issue,
in calculating how much GST the company owed in those four years, in a
consistent manner throughout the books.
The Evidence of Lisa Kelly
[79] Respondent counsel took Ms. Kelly, the appeals officer, through a
schedule prepared by Ms. Farina (Exhibit A-1, Tab 17), which contained the
CRA’s calculations of refund interest and penalty from the December 2000 reassessment
and proposed calculations showing how the Appellant thinks the interest and
penalty ought to have been calculated. Ms. Kelly stated that she agreed with Ms.
Farina’s recalculations of interest and penalty “...give or take a few dollars”
(Transcript page 848). In referring to the Recalculation of Reassessment (Exhibit
R-2), Ms. Kelly explained that the documentation showed the interest and
penalty refund amounts owing to the Appellant as of June 5, 1998, the date of
the original assessment. As of December 22, 2000, the date of the reassessment,
the amounts would be the same but the Appellant would receive credits on those
amounts.
[80] On cross-examination, she stated that it was section 232 of the Act
that was used in completing the December 2000 reassessment. She also explained
that misrepresentation occurred, with respect to the back-charges, when amounts
were charged back to subcontractors, whose work was remedied, that included the
consideration plus GST but no adjustment was made to the GST component in this
respect.
The Issues:
[81] The issues are:
(1) Whether the
period from January 1, 1991 to June 5, 1994 is statute barred within the
meaning of subsection 298(1) of the Act.
(2) Whether the Appellant is liable for the
penalties assessed under section 280 of the Act.
(3) Whether the Appellant is entitled to the
ITCs.
The Appellant’s Position
[82] The period under appeal is from January 10, 1991 to November 30, 1995.
The assessment is dated June 5, 1998. The Appellant contends that the Minister
is barred from reassessing the Appellant on GST returns filed prior to June 5,
1994. The audit started in January 1996 with the matter being discussed with
special investigations as early as January 25, 1996 and formally referred to
that department in May 1996. No assessment took place until June 1998. A waiver
was not requested. Eventually the amount of back-charges was reduced by
$120,000.00 and the allegation of gross negligence was not pursued. The
Minister is now “...scrambling to come up with ... misrepresentation”
(Transcript page 1022). The Appellant argues that the Respondent should
not have the advantage of reassessing outside the normal reassessment period on
the basis of misrepresentation simply because it disagrees with the taxpayer’s
filing position. The Appellant had a bona fide filing position
respecting the back‑charges as well as the calculation of GST on PST.
This is a difference of opinion which does not equal misrepresentation. There
is no calculation error respecting back‑charges and the Appellant’s
interpretation of the applicable provisions in the Act are correct. Even
if that interpretation is wrong, it was bona fide and reasonable and
therefore not a misrepresentation.
[83] The Appellant submits that GST is a small administrative portion of
its business, that the back-charges make up a miniscule portion of the ITCs it
claims and that the back-charges at issue are an even smaller portion of that
amount. The approach taken by the Appellant on the back-charges is correct but
in the alternative a bona fide filing position cannot amount to a
misrepresentation.
[84] The Appellant asserts that where a back-charge is made, the provision
that applies is section 232. Subsection 232(2) allows the parties to adjust GST
in the event, that the consideration upon which it was based, is subsequently
reduced. The Appellant argues, that since section 232 is an optional provision,
one does not have to adjust unless there is some other specific section that
requires a taxpayer to adjust. Moreover, this is so even if section 232 does
not apply. The Minister’s interpretation that a taxpayer must adjust GST and
the related ITCs under other provisions of the Act, even if section 232
does not apply, cannot be correct. If the Minister’s interpretation is correct,
then the option provided pursuant to section 232 is illusory. The Appellant
submits that if a taxpayer exercises an option not to adjust pursuant to
section 232, then he should not be asked to adjust under another section of the
Act.
[85] Finally, the Appellant argues that the penalties should be deleted
because subsection 280(1) cannot apply where the Appellant has exercised
reasonable care and due diligence. Since the Appellant took all reasonable
precautions and had all necessary systems in place, it should not be
responsible for the acts of its comptroller, who was criminally convicted of
defrauding the Appellant of close to one million dollars, or for the acts of
the external accounting firm.
The Respondent’s Position
[86] The Respondent submits that the Appellant made a misrepresentation
that is attributable to neglect, carelessness or wilful default, and thus,
subsection 298(4) applies. The Appellant should have adjusted the original
invoices from the subcontractors to reflect the appropriate GST adjustment, and
in failing to adjust, the Appellant made a misrepresentation. Since the
Appellant passed on approximately $153,000.00 in GST to the original subcontractors
where no supply was provided by the Appellant, that amount must be taken into
consideration when the Appellant claims its refund by way of ITCs. If there was
no supply, no GST should have been charged. Only the principal consideration
should have been charged to the original subcontractor. In over-claiming ITCs
and in under-remitting GST on the PST portion of the subcontractor’s invoices,
the Appellant made a misrepresentation on its GST returns that is attributable
to neglect, carelessness or wilful default. The Appellant did not exercise due
diligence and is liable to pay penalties pursuant to subsection 280(1) together
with interest at the prescribed rate.
[87] The Respondent contends that the Appellant relied on its internal and
external accountants and that, since they were both agents of the Appellant,
their actions and intent were the very actions and intent of the Appellant
itself. Therefore negligence of the internal and external accountants is in
essence negligence attributable to the Appellant.
[88] The Respondent submits that section 232 does not apply as there was no
decision by the parties to adjust under this provision and in any event
Respondent counsel abandoned reliance on this section during the hearing.
However, the Appellant must adjust GST and related ITCs under other relevant
sections of the Act when section 232 is not being applied.
Analysis
Issues # 1 and # 2
[89] I will address the issues of the statute barred
period and penalties together as they tend to overlap in the evidence.
[90] Subsection 298(1) provides a time limit of four
years for the CRA to issue an assessment. However, under subsection 298(4), if
certain conditions are met, an assessment can be made at any time beyond the
four year limitation period set down in the Act. Since a waiver was
never requested and fraud is not alleged, we are dealing with paragraph 298(4)(a)
which states:
An assessment in respect of any
matter may be made at any time where the person to be assessed has, in respect
of that matter,
(a) made a misrepresentation that is
attributable to the person’s neglect, carelessness or wilful default;
The onus is on the Minister to establish the existence
of misrepresentation that is attributable to neglect, carelessness or wilful
default. To succeed, the Minister must first establish that there was a
misrepresentation made by or on behalf of the Appellant, and second, that the misrepresentation
is attributable to neglect, carelessness or wilful default.
[91] Penalties and interest are imposed pursuant to
section 280 of the Act where a taxpayer fails to remit or pay an amount
as required. In assessing the Appellant for penalties, the Minister relied on
subsection 280(1) which states:
Subject to this section and
section 281, where a person fails to remit or pay an amount to the Receiver
General when required under this Part, the person shall pay on the amount not
remitted or paid
(a) a penalty of 6% per year, and
(b) interest at the prescribed rate,
computed for the period beginning on the
first day following the day on or before which the amount was required to be
remitted or paid and ending on the day the amount is remitted or paid.
Penalties assessed pursuant to this provision, are of
course susceptible to the Appellant raising the implied defence of due
diligence. A taxpayer will not be penalized under this section if due diligence
was exercised in attempting to comply with the legislation (Canada (A.G.) v.
Consolidated Canadian Contractors Inc., [1999] 1 F.C. 209 (F.C.A.),
explaining Bowman J.’s widely approved of decision in Pillar Oilfield
Projects Ltd. v. Canada, [1993] G.S.T.C. 49 (T.C.C.)). This provides
registrants the opportunity to exculpate themselves in respect to the penalties
if they can demonstrate that they “exercised reasonable care in attempting to
ascertain the correct amount of GST owing” (Consolidated Canadian
Contractors at paragraph 52).
[92] In essence then, the issue of misrepresentation as it
applies to both sections 298 and 280 turns on whether the Appellant
exercised reasonable care in respect to the two transactions (the GST on PST
and the back-charges). Under section 298, the statute barred years may be re-opened
only if the Minister can establish that the Appellant, in failing to exercise
reasonable care, committed a misrepresentation due to neglect, carelessness or
wilful default. Under section 280, the Appellant may escape the penalties if it
can show that it exercised reasonable care in dealing with these transactions.
[93] The Federal Court (Trial Division) in Venne v.
The Queen, 84 DTC 6247 at 6251 discussed the standard of care
required of a taxpayer under sub‑paragraph 152(4)(a)(i) of the Income
Tax Act, the equivalent of subsection 298(4) of the Excise Tax Act
and containing much the same wording:
I am satisfied that it is
sufficient for the Minister, in order to invoke the power under subparagraph
152(4)(a)(i) of the Act to show that, with respect to any one or more aspects
of his income tax return for a given year, a taxpayer has been
negligent. Such negligence is established if it is shown that the
taxpayer has not exercised reasonable care. This is surely what the
words “misrepresentation that is attributable to neglect” must mean,
particularly when combined with other grounds such as “carelessness” or “wilful
default” which refer to a higher degree of negligence or to intentional misconduct.
Unless these words are superfluous in the section, which I am not able to
assume, the term “neglect” involves a lesser standard of deficiency akin to
that used in other fields of law such as the law of tort.
[94] Due diligence in the context of section 280 was
discussed in Pillar Oilfield, supra. At pages 49-4 and 49‑7,
Justice Bowman wrote:
… It is, I think, contrary to ordinary
concepts of fairness that a taxpayer should be penalized for a failure to
observe a statutory provision or to calculate tax correctly if that taxpayer
demonstrates that even with the exercise of due diligence the mistake was
unavoidable. …
Innocent good faith does not, however,
amount to due diligence.
[95] The term due diligence was again described by
Justice Bowman in Wong (E) v. Canada, [1996] G.S.T.C. 73-1 (T.C.C.) at
73-5, as follows:
... Due diligence is nothing more than the
degree [of] care that a reasonable person would take to ensure compliance with
the Act. It does not require perfection or infallibility. It does,
however, require more than a casual inquiry of an official in the Tax
Department. (Emphasis mine.)
[96] For the Minister to
be successful in re-opening the statute barred years respecting the back-charge
transactions, it must be shown that the Appellant committed a misrepresentation
in completing its returns and that the mistake was the result of neglect,
carelessness or wilful default. The processes, which led to the establishment
of the back-charges and the calculation of the GST on PST, are clearly outlined
in the evidence. Basically, when a subcontractor was responsible for deficient
work the Appellant hired a second subcontractor to correct it and this second subcontractor
charged the Appellant for the remedial work together with GST, for which the
Appellant claimed an ITC. The entire amount paid to this second subcontractor,
including the GST portion, was back-charged to the original subcontractor, who was
asked to pay the amount or alternatively have his progress payments on the
original contract reduced by that amount. Ms. Farina in giving her evidence
explained that a notification letter was generated by the Appellant’s accounts
department and then forwarded to the original subcontractor whose work had been
remedied. The documents in support of Ms. Farina’s explanation of the procedure
were taken primarily from the working papers of the external accountants. The
same procedure was followed each and every time; if there were exceptions, none
were picked up. Although this notification letter talks about a credit note,
the evidence of both Ms. Farina (the Appellant’s current external accountant) and
Mr. Pyeon (a CRA technical advisor) confirmed that no debit notes were ever
processed. It was the Appellant’s contention that no debit notes were generated
because in reducing the contract consideration, neither party was making an
adjustment of tax. According to the Appellant’s argument, the parties did not
exercise the option to adjust under section 232 and therefore no credit note or
debit note had to be generated. Under subsection 232(2) no adjustment of tax
was therefore required and there is no other specific section that requires the
parties to adjust. I do not agree with the Appellant’s interpretation here.
First of all, the Respondent abandoned section 232 during the hearing and
agreed that it did not apply in the circumstances of this appeal, even though
the Reply initially indicated that it was section 232 that required the adjustment.
There was certainly confusion as to which section of the Act should be
applied. Ms. Kelly, the appeals officer, testified that she relied on section
232 to assess the Appellant for the over-claimed ITCs where there was a
back-charge. Mr. Pyeon’s evidence was that he used a completely different
section, section 169 (entitlement to ITCs), when he completed his audit. He
stated that in his opinion section 232 did not apply.
[97] I do not agree with
the Appellant’s interpretation of the provisions of the Act, however I
believe that the Appellant’s interpretation, although wrong, may be bona
fide and reasonable particularly where CRA officials could not agree on
which provisions should govern the back-charge transactions. But does the
Appellant’s interpretation amount to a misrepresentation? None of the Appellant’s
records suggest that the company was covertly adjusting the ITCs. Everything
was open and obvious. During cross-examination, Mr. Pyeon agreed that a
difference of opinion as to which section of the Act may apply to a
transaction does not amount to a misrepresentation. On cross-examination, he also
agreed that the Appellant’s records were consistent in not adjusting tax. There
was no evidence to suggest that the Appellant ever attempted to adjust for ITCs
where there was a back-charge. Mr. Pyeon, when asked if the Appellant had tried
to misrepresent the ITC adjustments, replied that he could not tell and that he
simply did not know.
[98] Respecting the calculation
of GST on PST, Ms. Farina testified that it was also recorded in an open
fashion and that each transaction was dealt with consistently by the Appellant.
The evidence established that the Appellant did not hide, or attempt to hide,
the fact that adjustments were made. The Appellant conceded the amounts
respecting these transactions and thus they are not at issue.
[99] I agree with the
Appellant’s contention that a bona fide approach to adjusting the tax
cannot, in these circumstances, constitute a misrepresentation, particularly
where Agency officials cannot agree on the appropriate sections of the Act
that govern the transactions.
[100] So, in the final
result, do I have any evidence before me establishing that the Appellant made a
misrepresentation to the Minister? There was no such evidence provided to me.
Although the Appellant’s approach, I believe, was incorrect, I do not believe
it amounted to a misrepresentation to the Minister. I appreciate that this
Appellant has been put in a difficult position, not only because of the passage
of time, but also because the principal players that have so affected this
outcome have either been found criminally liable for fraud and jailed (the
Appellant’s comptroller, Mr. Kar) or are being sued by the Appellant (the
external accountants, Martyn, Dooley & Partners). The Respondent did not
specifically refer to a single GST return that contained a misrepresentation.
When Ms. MacNeil was questioned respecting her determination to assess beyond
the statutory limitation period, she stated that one of her reasons was “...
because the amount was significant for GST purposes ...” (Transcript page 658).
Quantum is certainly not sufficient for the Minister to find a
misrepresentation; and even if by some stretch I could find that it was, the
amount was relatively miniscule when viewed in the context of the overall
business revenue of the Appellant, where hundreds of millions of dollars in
transactions took place over a five‑year period. Ms. MacNeil then went on
to state some of her other reasons, which were “... because the company had an
internal accountant for the majority of the time of the assessment who stated
that he did it knowingly and because if he’s guilty of doing this so therefore
is the company ...” (Transcript pages 658 – 659). On cross-examination, she
admitted that her perception was based on conversations she had with Mr. Kar.
Given Mr. Kar’s conviction on charges of defrauding the Appellant of close to
one million dollars, I would not accept as credible or remotely reliable any
such representations he is alleged to have made, even if they were admissible.
In the next portion of Ms. MacNeil’s response, she stated that a further
reason was “... because they hired another internal accountant who was also a
C.A., and he didn’t inform the auditors of the two different sales invoices
when the auditors went out there; there were two different and complete
separate sales invoices and the third party – the ones provided to the third
parties were never shown to the auditors” (Transcript page 659). Although there
were no specifics in the Reply to the Notice of Appeal respecting this
allegation, Ms. MacNeil is stating that Mr. Dickinson, the internal
accountant hired to replace Mr. Kar, did not give copies of the progress
certificates to the auditors and that this supported a misrepresentation. First,
as rightly pointed out by Appellant counsel, even if there was such a
misrepresentation by Mr. Dickinson to the auditor, Phil Soosaithasan, the
proper way to prove such an allegation is by calling Mr. Soosaithasan. Ms.
MacNeil admits she was not present; and because of the number of intervening
years, even if I were to disregard evidentiary rules and give some sort of
credence to this allegation, I could not give it any weight. The audit file
contained notes belonging to Mr. Soosaithasan (filed on consent as Exhibit A-4)
which indicate that he reviewed many invoices and documents. He went to a third
party to obtain a progress certificate which he then checked against the
worksheet that the Appellant (according to Ms. Farina’s evidence) used to
calculate the GST. Since Mr. Soosaithasan did not testify, I can only speculate
that on comparison of these documents, being the progress certificate and the
worksheet, he would see a discrepancy. I assume this to be the case because at
the third page of Exhibit A‑4 it was noted that the Appellant’s
officers were co-operative in providing other necessary documents when
requested. His notes confirm that he requested further records and that he
received them. These notes contradict the evidence provided by Ms. MacNeil in
Court, who in any event was not present with Mr. Soosaithasan at the
Appellant’s offices. It is clear that Mr. Soosaithasan knew that the
Appellant was openly making a reduction for PST and then applying GST on the reduced
amount because the Appellant kept the calculations on a worksheet with the GST
filings to show exactly how the calculations were being made. This is not the
method the Appellant would employ if it were intent on misrepresenting those
calculations and concealing them. There was no such attempt here. Contained in
the special investigations’ file (Exhibit A-5) were two memoranda from Ms. MacNeil
that outlined her conversations with the CRA audit team: one on January 25,
1996 and one prior to the referral to special investigations on May 24,
1996. There is no reference of a specific misrepresentation made to the
Minister or that the Appellant’s officers were not being co-operative. Her
notes merely document her discussions with Mr. Soosaithasan and in those
notes she summarized the tax adjustments made by the Appellant. In fact, in her
January 25, 1996 notes, Ms. MacNeil stated that she advised Mr. Soosaithasan
that the Appellant “could have reasons” for adjusting the tax.
[101] Now, with respect to
the GST on PST adjustments, as they relate to the statute barred issue, the
Appellant utilized the 2.7407% formula to calculate the GST on a reduced contract
price, and as a result it under-remitted GST. Since the introduction of GST, it
has become a recognized principle that general retail sales tax is to be
excluded from GST calculations. I do not believe it is such a giant leap to
expect that the Appellant would accept that it was reasonable to not charge GST
on PST. Devising a formula to accomplish this, however, does not amount to a
misrepresentation. Certainly the Appellant under remitted GST and should have
dealt with it differently. It was the responsibility of Martyn, Dooley to
detect this error and inform the Appellant. The Appellant did not take the
position that the correct procedures were instituted in respect to the GST on
PST issue but that the evidence does not support a conclusion that the
Appellant made a misrepresentation to the Minister. If the Appellant concluded
that it was correct to back out the GST on the PST, is it a misrepresentation to
the Minister to include it in income where the internal chartered accountant devised
the formula and the external accounting firm sanctioned it but never advised the
Appellant to change its procedures? In addition can there be a
misrepresentation when the records were open and obvious for anyone viewing them,
with the worksheets attached to the GST filings and returns? I do not believe
so, particularly when one looks at the period under appeal. It was during the
inception of the GST tax, when confusion existed respecting its implementation.
The Appellant made no attempt to conceal the GST it under-remitted either in
books, records or accounts. It was simply viewed as not owing to the Minister and
therefore it was included in income and taxes paid on it. I do not believe this
means the Appellant was negligent or careless and certainly it is not evidence
of wilful default. The crux of the problem here is with accountants. It is
unfortunate when transactions such as these are not recognized as problematic
by an internal accountant, who appears to have had his own agenda respecting the
Appellant’s revenue, but it is tragic when first rate external accountants
examine these records year after year and place their seal of approval on those
procedures utilized by the Appellant. There was no reason for the Appellant to
hide anything from the CRA auditors. All the professionals, whom the Appellant hired
and paid, told the Appellant everything was fine. The Respondent argued that
the Appellant relied solely on its own viewpoint and did not seek advice
regarding the specific method it adopted for the GST on PST adjustments and the
back-charges. This is simply not correct. The Appellant formulated the
calculations but all adjustments were in plain view for the external
accountants to review and take issue with, if they felt there were potential
problems.
[102] Ms. MacNeil testified
that the Appellant created two sets of invoices (being the customer invoices
and the invoices shown to the auditor). However this is not quite accurate. Firstly,
regarding the supposed ‘customer invoices’, Ms. Farina explained that in the
construction industry no one gets paid based on an invoice and, in fact,
invoices are generally not forwarded to the customer. Rather, parties are paid pursuant
to a certificate of payment. In the present case, the Appellant received
payment based on the certificates of payment and the evidence does not suggest
that they were altered in any way to support some elaborate scheme to collect
GST but not remit it.
[103] Secondly, the
worksheets created by the Appellant (the supposed ‘invoices’ shown to the
auditor) would not be considered invoices in the construction industry and the
Appellant did not receive payment based on them. Accordingly, I find that these
worksheets were not invoices as suggested by Ms. MacNeil. They were simply the
means used to document and track all of the adjustments because everyone
believed they were acceptable. There is no misrepresentation here. Everything was
in full view for anyone perusing the books to see and the Appellant utilized
the same tracking method for every transaction involving huge amounts of money over
a period of years.
[104] Assuming I had found a
misrepresentation here, which I have not, there is no evidence of neglect,
carelessness or wilful default on the part of the Appellant. Therefore, the
Minister could not satisfy the second part of the test even if I found a
misrepresentation. The Appellant implemented many systems to ensure proper
compliance with this new legislation. It retained a full‑time internal
auditor who was a chartered accountant, accounting staff typical of a business
the size of the Appellant, and a top rated external accounting firm. A premier
accounting and software system was maintained and the highest level of audit
was employed. Both Ms. Farina and Mr. Pyeon testified that the Appellant fully
employed these systems and that every transaction was recorded in a consistent
manner throughout the books. The Appellant was never told to change anything.
There was no hint that something might be amiss. Large sums of money were
expended to implement an elaborate system of checks and balances. The Appellant
provided the CRA auditors with full access to all of its documents and the
evidence would suggest that it did so co‑operatively. It is simply not
possible for me to conclude that this taxpayer was guilty of neglect or
carelessness and certainly not wilful default. Martyn, Dooley had access to all
of the Appellant’s records. The evidence is that this accounting firm knew full
well from the worksheets that the GST on PST was being adjusted using a formula
of 2.7407%. The worksheets and other documentation paint a full picture of what
the Appellant was doing. Yet none of the GST reasonability tests or the
significant matters memos raise any concerns respecting this calculation in any
of the years. In fact, evidence that Martyn, Dooley considered these
adjustments appropriate and proper is indicated at Exhibit A-3, where at page
70, under the heading “Following to be reviewed with Ralph Aquino”, only a very
minor GST matter involving a vehicle was raised, for which Martyn, Dooley thought
Revenue Canada might take exception. If Martyn, Dooley saw the calculations and
did not know they were incorrect, how can it be said that the Appellant should
have known and that there was some neglect, carelessness or wilful default here
of which the Appellant is guilty?
[105]The Respondent argued
that Mr. Sudan of Martyn, Dooley discussed the GST on PST issue during the meeting
in June 1995 with Mr. Kar and Mr. Aquino. I was also referred to the 1994
significant matters memo (Exhibit A-3) containing the handwritten notes. Respondent
argued that the evidence suggests that the matter of having two sets of
invoices – of collecting GST and remitting less than collected – was discussed
with the Appellant during that meeting as evidenced by these notes, and yet despite
this knowledge, the Appellant decided to continue with the practice for several
months after the meeting until November 1995. Although I intend to address this
item in my analysis of the penalty issue, I cannot conclude that the evidence
supports the Respondent’s characterization of these events. The Appellant’s
principal contact person at Martyn, Dooley was Mr. Sudan. I reject Mr. Sudan’s testimony in its
entirety. He was the most unreliable witness I have ever had before me. I view anything
he said under oath as totally self‑serving and suspicious. I reject his entire
evidence with respect to this significant matters memo and the handwritten
notes appearing on its face.
[106] Martyn, Dooley,
according to Ms. Farina’s evidence, was employed at the highest level of
engagement and one of the crucial aspects of such an engagement is to identify
potential issues and problems for the taxpayer that is employing them. It must
be one of the important reasons a taxpayer would decide to pay huge sums of
money for the highest level of accounting advice. Certainly if Martyn, Dooley
felt a minor GST issue involving a vehicle was important enough to reference
for discussions with Mr. Aquino, then the open, obvious and problematic GST
calculations at issue here should have reduced them to shell shock. Yes, Martyn,
Dooley should have known, but a reasonably prudent taxpayer such as the
Appellant would not and could not be expected to. There is no negligence or
carelessness on the part of the Appellant and certainly no evidence of wilful
default.
[107] But can negligence be
attributed to the Appellant because it hired internal and external accountants
so that the resulting relationship makes the actions of the servants/employees
that of the master/employer? Although I believe that my finding (that the
Appellant made no misrepresentations to the Minster) ends the matter, both
Respondent and Appellant counsel spent considerable time addressing this issue
and, for this reason, I wish to make the following comments. Agency principles
propose that if an agent can be said to be the directing mind and a vital organ
of the corporate entity, then his actions and intent, within the sphere of his
assigned duties and responsibilities, become the very action and intent of the
corporation itself. This renders the corporation liable for the agents’
actions. However, this principle applies only to the extent that the agent was
acting within the scope of his authority, either express or implied. Mr. Aquino
did not have the education or knowledge to deal directly with GST matters and
even if he did, in a company that size, he would, out of necessity, have to delegate
those matters. Mr. Kar was certainly the main man in respect to GST matters
within the corporation. While many of the systems put in place may have been at
the request of Mr. Kar, I do not believe for one second that he would have
implemented any of these elaborate mechanisms unless Mr. Aquino acquiesced. Mr.
Aquino presented as an individual who was a “hands on” owner. He testified he
spent many hours in the field overseeing the projects. He is a self‑educated
man and this is where his expertise lies. I think the only time he may have
given Mr. Kar more reign was during the period in 1994 when his wife was ill
and subsequently died. Before Mr. Kar perpetrated the fraud, Mr. Aquino trusted
his judgment and suggestions respecting tax matters, but Mr. Aquino had no choice.
It is interesting to note that on the significant matters memo, it was Mr. Aquino’s
name, not Mr. Kar’s, that Martyn, Dooley referenced, for discussion of issues
raised. Mr. Aquino testified that he was always present when Mr. Sudan attended at the Appellant’s
offices to review its statements and returns. Mr. Aquino did not abdicate his authority
by delegating certain office responsibilities to Mr. Kar. Even if I found Mr.
Kar to be the directing mind, there is no doubt on the evidence before me that
he was acting outside the scope of his authority, and therefore, the Appellant
would not be responsible for his acts. This would also apply to the actions of Martyn,
Dooley if in fact the principles of agency could be extended that far. Mr. Aquino
retained ultimate control. It was his corporation and he worked hard through
the years to make it what it is today. Even if agency laws apply here, Mr. Kar
was not its directing mind.
[108] As much as Mr. Aquino
was able to understand, he attended the year end meetings and discussions with Martyn,
Dooley and attended to the final review and signing of the returns. He is not
someone who hired an incompetent bookkeeper to look after tax matters and then
ignored what was happening over a period of time. Mr. Kar was a chartered
accountant. He could never be characterized as patently inadequate because he
was so adept as a scoundrel that he swindled almost a million dollars from the
Appellant.
[109] In respect to the
external accounting firm, they were hired at the highest level of engagement to
review all records, audit financial statements and report on issues and
problems; however, this did not make the firm a directing mind of the Appellant
in respect to GST matters. They were negligent, careless, inadequate and inept
but they were not, perhaps thankfully, the directing mind of corporate affairs
for the Appellant. They were the last notch in a system of checks and balances
that the Appellant put in place and the Appellant paid huge sums of money for
their services. Regrettably for the Appellant, all of these elaborate systems failed
miserably.
[110] In summary, I conclude
that the Minister has not met the onus of establishing that the Appellant made a
misrepresentation to the Minister that was attributable to the Appellant’s
neglect, carelessness or wilful default. As a result, the period from January
1, 1991 to June 5, 1994 is statute barred within the meaning of subsection
298(1) of the Act and may not be re-opened.
[111] The second issue
involves the imposition of penalties pursuant to section 280 of the Act.
[112] Because of my
conclusion on the first issue (that the period January 1, 1991 to June 5, 1994
is statute barred), some of the penalties will be reduced accordingly. However,
the latter portion of the period under appeal does not fall within the statute
barred years and thus may be subject to penalties. The onus is on the Appellant
to convince me that I should reverse the penalties. To do so I must be
convinced that the Appellant exercised due diligence. Based on my analysis of
the statute barred issue, it almost necessarily follows that I find that the
Appellant was duly diligent for the purposes of the section 280 penalty. Each
case must turn on its own unique set of facts and certainly this case is in ample
supply of those. The evidence has clearly established that Mr. Aquino, the sole
shareholder, President and directing mind of the Appellant company, had neither
the education nor the knowledge in tax matters to deal “hands on” with this
particular aspect of his business. He knew his limitations and ensured the
proper systems were in place to deal with the complexity of this legislation.
An internal accountant and staff were hired to ensure compliance. A
sophisticated computer system and premier accounting software system were
installed. A reputable external accounting firm was engaged to complete the
highest level of accounting advice and he personally attended the meetings with
the representative of the external accounting firm.
[113] Ms. Farina explained
that the obligations of the external accountants would include making sure that
the appropriate procedures were in place to ensure GST compliance. She
testified that this would be a standard practice when paying for the highest
level of accounting or audited statements. Although engagement letters do not
specifically cover this, I accept Ms. Farina’s evidence that this is standard
practice. Ms. Farina presented herself as a highly professional, competent and
reliable witness who was knowledgeable and skilled in accounting matters. I was
very impressed with her testimony. I have no reason not to accept all of her
evidence. The Appellant engaged every possible internal and external control to
ensure compliance and there was nothing that would have alerted him to the fact
that his company was not in compliance. This was certainly an erroneous
assumption on his part, but one for which he cannot be deemed negligent. The
wording of the engagement letter from the external accountants (Exhibit A-1,
Tab 1), although pre-GST, provides the breadth of the types of professional
accounting services the Appellant engaged. Mr. Aquino testified that he took a
level of comfort and reliance on the accounting services he was paying for.
When the GST was introduced, the external accountants forwarded a letter to the
Appellant (Exhibit A-1, Tab 2) in which they referred to formulating a future planning
checklist to identify any GST planning opportunities, issues or potential
problems. This was forwarded to the Appellant, with eventual contact and follow‑up.
In another letter from Mr. Dooley, on behalf of his firm (Doane Raymond Pannell
at the time), dated May 13, 1991 (Exhibit A-1, Tab 3), the Appellant was
advised that the external accountants would ascertain whether the financial statements
were free of material misstatement and that they would assess the accounting
principles being used. I believe that these statements imply that GST
compliance will be part of their audit. In addition, I have Ms. Farina’s unchallenged
evidence that, although engagement letters do not normally refer specifically
to GST, it is clearly included when they agree to provide and receive payment
for a full service audit. The working papers of the external accountants
identified the GST calculations in issue but then failed to identify them as
problems. It is in fact quite remarkable and telling that, in Exhibit A-3, Tab
4, under the heading “commodity taxes”, the firm wrote:
Consistent with last
year – client maintains two sets of invoices one for customers to pay and one
to record GST collected on sales.
Mr. Kar’s calculations were open
and obvious throughout but Martyn, Dooley failed to identify them as problems on
any of the significant matters memos. According to Mr. Sudan’s evidence, he brought these problems
to the Appellant’s attention in June 1995. However, I have rejected all of Mr. Sudan’s evidence; and even if
I accepted his evidence on this one point, it was clear that it was beyond his
ability to convey or explain the serious nature of those problems to Mr. Kar and
Mr. Aquino. I base this conclusion on the fact that Mr. Sudan was unable to
follow a fairly simple GST calculation that Appellant counsel attempted to take
him through on cross-examination. There was nothing that was hidden or disguised
in Mr. Kar’s calculations and in fact Mr. Dickinson, who replaced Mr. Kar, was
able to identify these calculations as problematic very shortly after he
started working for the Appellant.
[114] The handwritten notes
of the external accountants in each of the reports on the working papers
contain no references to these GST issues to be discussed with Mr. Aquino. A
note to discuss GST on a vehicle can hardly compare to the magnitude of the
problem with Mr. Kar’s GST calculations. Mr. Aquino testified that none of the accountants
ever indicated any difficulties with GST or concerns with the way his company
was dealing with and reporting GST. If he had been so advised, he stated that he
would have acted immediately to correct these problems as he did when he paid
the amount owed to the CRA as soon as Mr. Dickinson informed him of the
problems. In addition, CRA officials had attended at the premises several times
to complete audits and he was not advised of any GST problems. So what other
reasonable actions could the Appellant have taken to ensure compliance? I know
of no other steps that the company could have taken except to proceed into the
realm of the ridiculous by speculating that the company should have also paid
for a second firm of external accountants to check on the work of the first.
This is just not a step that could be deemed reasonable in the every day
business world. If the Appellant had been suspect of Martyn, Dooley’s work,
then it could be said that it might be responsible and reasonable to have a
second accounting firm review the work. The Appellant however had no reason to
be suspicious.
[115] In addition, although
these GST amounts may seem large on their face, the shortfall on a month‑by‑month
basis was small in comparison to the total revenues generated by the Appellant.
The Appellant had to pay a significant amount of GST but the difference between
what was remitted and what should have been remitted is small and certainly not
significant enough that Mr. Aquino, or anyone else signing the cheques and
seeing the GST returns, should have caught or be reasonably expected to have
caught.
[116] Mr. Aquino placed
great reliance on Mr. Kar, his comptroller. He placed him in a greater position
of trust in 1994 when his wife was ill. It was at this time that Mr. Kar
perpetrated the fraud of almost one million dollars against the company.
However throughout the entire period, the Appellant maintained its supporting
systems of software package, computer system, inside accounting staff and
professional external accountants as the ultimate system of checks and
balances.
[117] And finally we have
Mr. Sudan who was the only partner of the external accounting firm, Martyn,
Dooley, and its predecessor firms, to have direct contact throughout this
period with Mr. Aquino. As the representative of the external accounting firm,
he had been involved with the Appellant since 1987 or 1988. He was the
individual that reviewed the audited statements and accounting practices with Mr.
Aquino. And yet it was Mr. Sudan’s testimony that he neither reviewed nor, more importantly,
even understood the working papers. Mr. Sudan holds himself out as a
professional chartered accountant, but one who admittedly could not have recognized
and identified this problem as a significant one for the Appellant. He
testified that he looked only at the significant matters memo and if no GST
issue was identified there, it would never be brought to Mr. Aquino’s attention.
Ms. Prapavessis did the actual audit and her work was reviewed by Mr. Dooley,
the audit partner. We know from the working papers that Martyn, Dooley was
aware of the GST calculations, and yet year after year the firm never informed Mr.
Aquino. Suddenly in June 1995, according to Mr. Sudan, while he was finalizing the
statements, he presented the problem to Mr. Aquino, just a day or two before
the returns were due for filing. Mr. Sudan suggested during his testimony that Mr. Aquino just did
nothing. Yet Mr. Aquino’s own evidence is that when Mr. Dickinson discovered
the problem, he (Mr. Aquino) was absolutely shocked; he corrected the problem
immediately and wrote a cheque to the CRA for almost two million dollars that
nearly bankrupt his company. I do not know how Mr. Sudan could have identified it as a
problem, when according to his evidence, he did not even know that this could
be a problem. Quite an admission from the individual who was Mr. Aquino’s
principal contact person at Martyn, Dooley and the person ultimately
responsible for bringing such problems to Mr. Aquino’s attention. This was
astonishing but perhaps not surprising considering that this same witness, a
chartered accountant and the contact person for the Appellant, could not follow
Appellant counsel through a simple GST calculation on cross-examination. I have
rejected Mr. Sudan’s
evidence in totality and I certainly did not believe him when he told me that
he informed Mr. Aquino about this problem in June 1995. However if I were to believe
anything that he did tell me, it would be his initial assertion that the handwriting
on the significant matters memo was not present when he met with Mr. Aquino
in June 1995. On direct examination by Respondent counsel, Mr. Sudan testified that this
handwriting came after June 1995; however on cross-examination, he changed his
evidence. Eventually, after see-sawing back and forth, he settled on a
statement that the handwritten notes “could have been there” in June 1995. I do
not believe that those marginal handwritten notes were present when Mr. Sudan met with Mr. Aquino in
June 1995. How or why they magically appeared after this date is best left for
another court at another time. All of this amounts to stunning incompetence and
is not the type of conduct for which the Appellant can be held responsible.
There was simply no amount of due diligence that could have alerted the
Appellant to this problem. He hired the right people, put the right systems in
place and expended huge sums of money to ensure compliance. Unfortunately the Appellant
ended up surrounded by amazingly incompetent individuals, one of whom was also a
crook. Under reasonable circumstances, all of these systems should have worked
for the Appellant. If the external accountants had completed their audits to
the level of competency for which they were hired and paid, the improper GST
calculations would have been earmarked early on and rectified. But the evidence
here clearly establishes that the Appellant has acted reasonably and prudently
and cannot be punished for the conduct of its external accountants where their
level of incompetence and negligence was so great that no amount of due
diligence beyond that demonstrated by the Appellant would have avoided the
problem. It is totally unreasonable to suggest that the Appellant somehow
should have been alerted to the problem through the exercise of due diligence
when professional people hired and paid to do this very thing, identified the problematic
GST calculations but failed to recognize that they were problems.
[118] I am satisfied on the
evidence that the Appellant did everything that it could be reasonably expected
to do in order to comply with the Act. The Appellant was duly diligent
in that it exercised the degree of care that a reasonable person would take to
ensure such compliance. Any penalties assessed in respect to the period not
statute barred will be deleted.
Issue #3
[119] It is best to address
this issue, from the perspective of the following question: who is entitled to claim the ITCs?
To answer this question, it is necessary to review the relevant provisions of
the Excise Tax Act, namely the former subsection 123(1), the present subsection
123(1) and subsection 169(1).
[120] Initially, the Excise Tax Act
defined “recipient” as follows:
123.(1) “recipient”, in
respect of a supply, means the person who pays or agrees to pay consideration
for the supply or, if no consideration is or is to be paid for the supply, the
person to whom the supply is made;
In 1993, an amended definition was introduced and made effective
retroactive to December 17, 1990. The new definition, which is still in force
today, appears in the present subsection 123(1):
123.(1) “recipient” of a supply of
property or a service means
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(a)
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where consideration for the supply is payable under an agreement for the
supply, the person who is liable under the agreement to pay that
consideration,
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(b)
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where paragraph (a) does not apply and consideration is payable for the
supply, the person who is liable to pay that consideration ...
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and any reference to a person to whom a supply is made shall be read as
a reference to the recipient of the supply.
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The general rule
for determining ITCs is contained in subsection 169(1), which during the
relevant period read as follows:
169.(1) Subject to this
Part, where property or a service is supplied to or imported by a person and, …
tax in respect of the supply or importation becomes payable by the person or is
paid by the person without having become payable, the input tax credit of the
person in respect of the property or service … is the amount determined by the
formula
A x B
where
A is
the total of all tax in respect of the supply or importation that becomes
payable … or that is paid by the person during the period without having become
payable; and
B is
[…]
(c) … the extent
(expressed as a percentage) to which the person acquired or imported the
property or service for consumption, use or supply in the course of commercial
activities of the person.
[121] Under subsection 169(1),
the person entitled to claim the ITC is the person to whom the supply is made;
and under subsection 123(1) that person is deemed to be the “recipient”.
Accordingly, for the purposes of the Excise Tax Act, it is the recipient of the supply
who is entitled to claim the ITC. Who, then, was the recipient in the present
case? In both subsections 123(1) and 169(1) the focus is on: who is liable to
pay for the supply (and thus the tax on that supply)? The language of these
provisions and just simple logic dictate that the intent of subsections 123(1)
and 169(1) is to allocate the ITC to the person who actually paid the GST on
the supply.
[122] The evidence shows that
there were agreements in the form of invoices between the Appellant and the
subcontractors hired to do the remedial work. Does it follow that
paragraph 123(1)(a) applies such that the Appellant (being the person
liable on the face of the agreement) becomes the “recipient”? Not necessarily.
Subsection 123(1), and in particular, the relationship between
paragraphs 123(1)(a) and (b), was considered by this Court in Immeubles Sansfaçon Inc. v. Canada, [2000] TCJ No. 603. In that case, Tardif
J. determined that:
[33] … in a case where consideration
has to be paid, the recipient is the one who, ultimately, under an
agreement for a supply [according to paragraph (a)] or otherwise [according to
paragraph (b)], is liable to pay that consideration.
[34] The situations provided for by
paragraphs (a) and (b) are mutually exclusive in the sense that there cannot be
two separate recipients, one under paragraph (a), the other under paragraph (b).
This does not mean, however, that if there is an agreement for a supply,
paragraph (a) cannot apply. Paragraph (b) could apply despite the existence
of an agreement for a
supply in a case where the person liable to pay under that agreement is not
required to pay anything at all. [Note 5: Judge Dussault’s finding in 163410 Canada Inc. v. Canada,
T.C.C., No. 97-1752-GST-G, September 24, 1998 ([1998] G.S.T.C. 116)
appears to be consistent with this interpretation. In that case, the existence
of an agreement between the supplier and a third party intermediary did not
seem to pose an obstacle to the possibility of the appellant having a legal
obligation towards the supplier under paragraph (b) of the definition of “recipient”
in section 123 of the Act.]
[Emphasis added.]
[123] Thus, we must determine who was “ultimately”
liable to pay for the supply. In the present case, where a subcontractor’s work was deficient, it was
common practice for the Appellant to hire a second subcontractor to remedy the
work. The Appellant would then attempt to recover its costs for this remedial
work from the original subcontractor through a back-charge, that is, by seeking
a price reduction on the original contract equal to the amount paid to the second
subcontractor (including the GST paid). By accepting this back-charge, the original subcontractor
acknowledged its responsibility for the work deficiencies and assumed liability
for the invoice. Although the Appellant’s name appeared on the face of the
invoice, it was the original subcontractor, not the Appellant, that accepted
ultimate liability for the invoice including the GST on that invoice.
[124] There was also evidence that it was open to
a subcontractor to contest the back-charge, and in some instances, the
Appellant would reverse the back-charge. However, those cases are not at issue
in the present case. Rather, what is at issue are those cases were the
Appellant claimed ITCs on remedial work invoices even though its liability for
those invoices was successfully transferred to a subcontractor. In these latter
instances, I find that this subcontractor is the recipient and, accordingly,
the Appellant is not entitled to claim the ITCs. Although this sufficiently
disposes of this issue, I would like to briefly address the Appellant’s
arguments.
[125] The Appellant claimed that a back-charge
was intended to amend the original contract with a subcontractor and that this
is supported by the back-charge notification letter in which the Appellant
requested a credit note from the subcontractor. I do not agree. Had the
Appellant intended to reduce the original contract (and the related GST), it
could have either sent a debit note with the prescribed information or insisted
on receiving a credit note with the prescribed information; however, the
Appellant did neither. The notification letters do not amount to debit notes
and there was no evidence that any credit notes were ever issued to the
Appellant. It seems that the Appellant, rather than insisting on an adjustment
of the original contract, was content to let the subcontractor adopt
responsibility for the remedial work invoice by accepting the back-charge.
Thus, while a back-charge does offset the amount the Appellant owes the original
subcontractor under the original contract, it does not reduce the
original contract.
[126] The Appellant argued in the alternative
that the back-charge was an amount paid by the subcontractor to cover a loss
suffered by the Appellant (see Transcript at page 1314), which is not a taxable
supply and hence not subject to GST. I do not accept this argument. Where a
subcontractor receives a notification letter (including the invoice) and elects
to accept the back-charge without amending the original contract (through the
issuance of a credit note), it is clear that the subcontractor is accepting
liability for that particular invoice.
Conclusion
[127] In summary, the period
from January 1, 1991 to June 5, 1994 is statute barred, the penalties will be
deleted and the ITCs claimed in respect to the back‑charges, to the
extent they are not statute barred, will be disallowed. Since the Appellant has
been successful for the most part, I am awarding the Appellant two sets of
counsel costs.
Signed at Ottawa, Canada, this 18th
day of May 2005.
Campbell,
J.
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