Johnston v. The Queen, docket 2000-3700(IT)I (Informal Procedure)

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docket 2000-3700(IT)I

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Date: 20020308

Docket: 2000-3700-IT-I

BETWEEN:

MELANIE D. JOHNSTON,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasonsfor Judgment

Mogan J.

[1] On June 9, 1999, the Appellant pleaded guilty in an Ontario Court to the charge of fraud over $5,000 contrary to the Criminal Code of Canada. The amounts which the Appellant had obtained by fraud were taken from her employer primarily in the years 1994, 1995, 1996 and 1997. The Appellant was found guilty as charged; she was given a conditional sentence of nine months; placed on probation for three years; and ordered to make restitution to her former employer at the rate of $700 per month for several years. By notices of reassessment dated May 25, 1999, the Minister of National Revenue added the following amounts to the Appellant's reported income for the respective taxation years:

1994 $15,035

1995 19,629

1996 62,289

1997 13,337

[2] The Minister obtained the above amounts from the criminal proceedings in the Ontario Court. The Appellant filed notices of objection to the reassessments described above claiming that certain amounts which she had obtained by fraud were unauthorized salary increases for which tax was deducted at source; and that such amounts were included in her T4 slips and reported as income. The Appellant also claimed that she had paid $1,000 in 1997 by way of restitution. By notices of reassessment dated April 20, 2000, the Minister reduced the amounts previously added to the Appellant's reported income to recognize the fact that any unauthorized salary increases had already been taxed and that amounts paid as restitution could be deducted in computing income. Accordingly, the net amounts added to the Appellant's reported income and the fresh penalties assessed under subsection 163(2) of the Income Tax Act were as follows:

	Added to Income	Penalty s. 163(2)
1994	$4,164	$330.20
1995	4,130	553.00
1996	44,778	7,012.25
1997 Total	9,167 $62,239	1,227.50

[3] The Appellant has appealed from the reassessments of April 20, 2000 claiming that certain of the net amounts added to her reported income are excessive and also claiming that the penalties under subsection 163(2) of the Act are not justified. She has elected the informal procedure. At the commencement of the hearing, counsel for the Respondent pointed out that the tax plus penalty for the 1996 taxation year would exceed the $12,000 limit for informal appeals, and he asked if the Appellant wanted to waive relief in excess of $12,000 or transfer her appeal for 1996 to the general procedure. The Appellant elected to waive relief in excess of $12,000 for her 1996 taxation year.

[4] The Appellant has a high school education plus certain night courses in business taken at a community college. In 1992, she became an employee of Lofthouse Patterns Incorporated ("Lofthouse" or "Employer") doing general office work. Within a couple of years, her primary duties were bookkeeping. At some point in 1993 or 1994, the Appellant commenced a pattern of obtaining money from her Employer by fraudulent schemes. The three basic schemes followed by the Appellant were (i) unauthorized salary increases with Employer cheques payable to the Appellant for amounts in excess of her actual earnings; (ii) unauthorized use of Employer's credit cards to purchase goods for the personal use of the Appellant; and (iii) forging cheques in the Employer's name which were cashed for the benefit of the Appellant. This pattern of fraudulent schemes continued until the spring of 1997.

[5] The principal shareholder of the Employer is Jerome Wilson. He started working at Lofthouse in 1951. He purchased the business in 1981 and has operated it ever since. In May 1997, when the Appellant was on leave from work, Mr. Wilson's wife came into the office to help with the bookkeeping. She noticed certain payments out of the ordinary and drew them to her husband's attention. Mr. Wilson looked at the company's books and records and became concerned. He asked Deloitte & Touche (the outside auditors for Lofthouse) to have someone review the books and records for unauthorized payments and possible theft.

[6] Deloitte & Touche immediately assigned Carol Chiu to review the books and records of Lofthouse. Ms. Chiu was an articling accounting student at the time but she became a chartered accountant in 1999. She examined cancelled cheques over a five-year period, the use of the company credit cards, and the payroll. At the end of her review, she wrote a report to her supervisor dated June 25, 1997 which was entered in evidence as Exhibit R-2. Ms. Chiu's report was used as the basis for the criminal charges which were laid in July 1997 and as the basis for the reassessments which are under appeal. Exhibit R-2 identifies four basic sources of fraudulent activity and sets out the amounts which Ms. Chiu concluded that the Appellant had obtained from those sources. In summary, the four sources in Exhibit R-2 and the amounts attributed to the Appellant are as follows:

Unauthorized salary increases	$50,525
Possible personal benefit from Employer's CIBC Visa card	22,147
Possible personal benefit from Employer's Canadian Tire card	11,909
Possible personal benefit from cheques with doubtful signatures	28,010

Total	$112,593

[7] In the first reassessments dated May 25, 1999, the Minister added to the Appellant's reported income approximately $110,000 representing almost all of the total computed by Ms. Chiu as shown in Exhibit R-2 above. It was only after the Appellant objected to those reassessments and pointed out that the unauthorized salary increases of $50,525 had already been included in her T4 slips and had been reported as income that the Minister issued the second reassessments dated April 20, 2000. The net amount added to the Appellant's reported income in the second reassessments was $62,239 (see paragraph 2 above). That amount of $62,239 is approximately equal to the total in Exhibit R-2 ($112,593) minus the unauthorized salary increases of $50,525. I am satisfied that Exhibit R-2 is the basis of both the first and second reassessments.

[8] As stated above, Exhibit R-2 is the report of Ms. Chiu to her supervisor. There were three other exhibits entered containing more detail than Exhibit R-2:

R-3 contains Appendix 3 from Exhibit R-2 concerning CIBC Visa purchases with supporting documents.

R-4 contains Appendix 4 from Exhibit R-2 concerning Canadian Tire purchases with supporting documents.

R-5 contains Appendix 5 from Exhibit R-2 concerning cheques with questionable signatures with supporting documents.

Exhibits R-3, R-4 and R-5 were put before both the Appellant and Jerome Wilson in the course of their oral testimony. In Exhibits R-3 and R-4, the Appellant challenged certain amounts charged to the Employer's CIBC Visa or Canadian Tire credit cards which Ms. Chiu had designated as "possible personal benefits" to the Appellant. When Mr. Wilson testified, he accepted as correct certain charges for the benefit of Lofthouse which Ms. Chiu had designated as benefits to the Appellant, but he also identified many charges to CIBC Visa and Canadian Tire which were not for Lofthouse.

[9] Similarly, when reviewing photocopies of thirty Lofthouse cheques in Exhibit R-5, the Appellant admitted receiving and cashing thirteen of those cheques representing an aggregate amount of approximately $18,900 but, among the remaining seventeen cheques, she was doubtful about some and denied receiving others. When the same photocopies of Lofthouse cheques were placed before Mr. Wilson, he easily identified many cheques which were signed in his name but the signature was not his.

[10] Notwithstanding the Appellant's guilty plea in the Ontario criminal court proceeding, I found her to be a credible witness in her own appeal in this Court. She seems to be genuinely remorseful. Where there is a conflict between the Appellant's evidence and Mr. Wilson's evidence, I will accept the evidence of Mr. Wilson not on the basis of credibility but because he has had recent access to all relevant Lofthouse document; and the Appellant kept no record of what she took. Also, he had nothing to gain by appearing in this Court.

[11] In argument, counsel for the Respondent said that he would ignore the cheques totalling $6,246.52 which are listed on the last page of Exhibit R-2. The Respondent also agreed to reduce two CIBC Visa amounts for 1996 as follows:

October 1996 $2,504.83 becomes nil

November 1996 2,267.24 becomes $712

The aggregate 1996 reduction for CIBC Visa charges is therefore $4,059. There were no other material reductions in the amounts added to the Appellant's reported income for the years under appeal. After giving effect to the 1996 reduction, the net amounts which Revenue Canada has added to the Appellant's reported income are:

1994 $4,164

1995 4,130

1996 40,719

1997 9,167

[12] There are three issues in this case:

(i) assuming that the taxation years 1994 and 1995 are statute-barred in the sense that they were first reassessed on May 25, 1999 after the "normal reassessment period" as that phrase is defined in subsection 152(3.1) of the Act, was the Minister permitted to reassess for 1994 and 1995 under subparagraph 152(4)(a)(i);

(ii) if the Minister is permitted to reassess for all four taxation years, what amounts should be added to the Appellant's reported income with respect to the amounts taken from the Employer; and

(iii) are penalties justified under subsection 163(2) of the Act?

[13] I will consider the above three issues in order. As a matter of law, it is well established that funds or property appropriated or otherwise taken from an employer or from clients are income to the wrongdoer. See The Queen v. Poynton, 72 DTC 6329 and Buckman v. M.N.R., 91 DTC 1249. The amounts which the Appellant took from the Employer have the character of income in her hands. The amounts taken by unauthorized use of credit cards and forged cheques were not reported as income by the Appellant in her tax returns. Subsection 152(4) states when the Minister may reassess after the normal reassessment period has passed:

152(4) The Minister may at any time make an assessment, reassessment or additional assessment of tax for a taxation year, interest or penalties, if any, payable under this Part by a taxpayer or notify in writing any person by whom a return of income for a taxation year has been filed that no tax is payable for the year, except that an assessment, reassessment or additional assessment may be made after the taxpayer's normal reassessment period in respect of the year only if

(a) the taxpayer or person filing the return

(i) has made any misrepresentation that is attributable to neglect, carelessness or wilful default or has committed any fraud in filing the return or in supplying any information under this Act, or

(ii) ...

[14] I have no hesitation in finding that the Appellant's failure to report as income the amounts which she obtained from the Employer by unauthorized use of credit cards and forged cheques was a misrepresentation attributable to "neglect, carelessness or wilful default" within the meaning of subparagraph 152(4)(a)(i). Accordingly, the Minister was permitted to reassess for the 1994 and 1995 taxation years.

[15] Concerning the second issue, the Appellant had the burden of proving that the net amounts added to her reported income were wrong. The only year which she seriously challenged was 1996. Considering all of the evidence, I am satisfied that the amounts of unreported income for the years under appeal are:

1994 $4,164

1995 4,130

1996 40,719

1997 9,167

[16] Concerning the third issue, the Minister assessed penalties under subsection 163(2) of the Act which states in part:

163(2) Every person who, knowingly, or under circumstances amounting to gross negligence, has made or has participated in, assented to or acquiesced in the making of, a false statement or omission in a return, ... filed ... in respect of a taxation year for the purposes of this Act, is liable to a penalty of the greater of $100 and 50% of the total of

(a) ...

In Venne v. M.N.R., 84 DTC 6247, Strayer J. was required to consider the application of subsection 163(2), and he stated at page 6256:

... "Gross negligence" must be taken to involve greater neglect than simply a failure to use reasonable care. It must involve a high degree of negligence tantamount to intentional acting, an indifference as to whether the law is complied with or not. ...

[17] The Appellant's defence against the penalties under subsection 163(2) is quite simple. She stated that she did not keep any record of the amounts taken; and it never dawned on her to report those amounts as income. I believe her. The Appellant has only a high school education plus some night courses in business at a community college. The Appellant was not engaged in an ordinary commercial endeavour like the owner of a retail store or the operator of a service business. The amounts taken did not have the appearance of revenue like unreported sales or fees. In the circumstances of this case, I cannot find that the Appellant "knowingly has made a false statement or omission" in her tax return for any year.

[18] In argument, counsel for the Respondent withdrew the penalties under subsection 163(2) for the taxation years 1994 and 1995 because the net amounts ($4,164 and $4,130) added to the reported income were relatively small. Counsel argued, however, that the unreported amount ($40,719) for 1996 was large enough to justify the "gross negligence" penalty. He also argued that the unreported amount ($9,167) for 1997 was large enough because it followed 1996 in time.

[19] I agree with Respondent's counsel for 1996. What did the Appellant think this large amount ($40,719) was when she extracted it from the Employer through her employment? It was clearly not a lottery winning and she intended to keep it. In the words from Venne quoted above, the Appellant's failure to report the amount $40,719 in 1996 was indifference as to whether the law was complied with or not.

[20] The burden of establishing the facts justifying a penalty under subsection 163(2) is on the Minister. For 1996, the Minister discharged that burden. Although the unreported amount for 1997 was $9,167, it is significantly smaller than the amount for 1996. Also, the Appellant's state of knowledge or ignorance with respect to the "income" character of the amounts taken was the same when she filed her tax returns for 1996 and 1997, right up until the time when she was first reassessed in May 1999. I therefore find that the Minister did not discharge the burden for 1997.

[21] The appeals for all four years are allowed in part but only for the following purposes:

1994 - the penalty under subsection 163(2) is deleted but the amount added to reported income remains at $4,164;

1995 - the penalty under subsection 163(2) is deleted but the amount added to reported income remain at $4,130;

1996 - the amount added to reported income is reduced from $44,778 to $40,719 and the penalty under subsection 163(2) is sustained but adjusted in accordance with the reduced amount added to reported income; and

1997 - the penalty under subsection 163(2) is deleted but the amount added to reported income remains at $9,167.

The Appellant is not entitled to any further relief other than that specified above.

Signed at Ottawa, Canada, this 8th day of March, 2002.

"M.A. Mogan"

J.T.C.C.

COURT FILE NO.: 2000-3700(IT)I

STYLE OF CAUSE: Melanie D. Johnston and

Her Majesty the Queen

PLACE OF HEARING: Toronto, Ontario

DATE OF HEARING: December 14, 2001

REASONS FOR JUDGMENT BY: The Honourable Judge M.A. Mogan

DATE OF JUDGMENT: March 8, 2002

APPEARANCES:

For the Appellant: The Appellant herself

Counsel for the Respondent: James Rhodes

COUNSEL OF RECORD:

For the Appellant:

Name: N/A

Firm:

For the Respondent: Morris Rosenberg

Deputy Attorney General of Canada

Ottawa, Canada

2000-3700(IT)I