Citation: 2008TCC312
Date: 20080613
Docket: 2006-1949(GST)I
BETWEEN:
LOGICIELS UPPERCUT INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
[OFFICIAL ENGLISH
TRANSLATION]
REASONS FOR JUDGMENT
Angers J.
[1]
Logiciels
Uppercut Inc (hereinafter "Uppercut Software" or "Uppercut")
is appealing from an assessment made by the Minister of National Revenue ("the Minister")
under the Excise Tax Act (ETA) for the period from
September 1, 2000, to February 28, 2005. On
November 16, 2004, Uppercut Software, though its agent, signed a
waiver of limitation for the period from September 1, 2000, to
May 31 2001.
[2]
By
the assessment, the Minister added $44,311.40 as taxable supplies on which the
Appellant did not remit tax amounting to $3,101.80. The Minister also
disallowed a $2,016 input tax credit (ITC) in relation to a $33,127.20 debt
that the Minister did not consider a bad debt because it was to be set off
against a financial obligation of Uppercut Software to its debtor Fun Key
Studio Inc. ("Fun Key"), in the sense that each was a debtor and
creditor of the other.
[3]
The
Minister also imposed $1,948.26 in penalties under sections 280 and 285 of
the ETA.
[4]
During
the period in issue, Uppercut Software operated a business that created
software and provided computer and related services. In the course of an
audit, the Respondent's auditor noticed cash deposits into Uppercut Software's
bank account, with corresponding general ledger entries under "advances
and liabilities" as advances from directors.
[5]
Consequently,
the auditor prepared a list of all these deposits, some of which were
identified as injections of cash by directors Francis Langlois and Jean‑Louis Bertrand.
The auditor agreed that these deposits were advances by a director, and they
were not taxed. The auditor was satisfied about the source of the funds,
because the directors were able to provide evidence of withdrawals from their
personal accounts for each of the advances that they made into Uppercut Software's
account.
[6]
However,
the auditor did not receive similar evidence concerning nine cash deposits made
on dates ranging from July 22, 2002, to September 20, 2004.
The deposits were the subject of the first part of the assessment, and
were taxed as income. Each deposit, with the exception of a $311.40
cheque, consists of a cash amount ranging from $1,000 to $10,000. According to
the evidence, most of the deposit slips were signed by one Alain Roy. Mr. Roy
is also a director of Uppercut Software, and, according to Francis Langlois,
its agent, the amount of $44,311.40 is from Mr. Roy and consists of
advances to Uppercut just like those made by him and by Jean‑Louis
Bertrand. Despite a few attempts, Francis Langlois was unable to obtain proof
from Alain Roy of the source of the money that he advanced to Uppercut, since Mr.
Roy was not cooperating. It should be noted that Mr. Roy was not called
upon to testify at the hearing of the instant case.
[7]
According
to Mr. Langlois, the directors' advances, including the ones from Mr. Roy,
were made in order to enable Uppercut Software to [TRANSLATION] "stay
afloat" after incurring expenses on purchasing software. He noted that,
according to the profit and loss statement as at February 28, 2005,
Uppercut was not a profitable company, and had enough losses that it did not
have any taxes to pay. Being an accountant by profession, Mr. Langlois
looked after Uppercut's accounting personally. He says that, as of 2000, Uppercut
was practically not in business any longer, and that, even though it had
operated since 1996, it never had many customers. Mr. Langlois' role was
to look after accounting and financing, and the role of Jean-Louis Bertrand, whom
he described as being [TRANSLATION] "in charge", was to look after
software programming and development, whereas Alain Roy was a mere shareholder
who worked in the construction business, not in software. Mr. Langlois sent
a letter to the auditor identifying the shareholders who had injected money, and
he included the requisite evidence, except with respect to Mr. Roy, who had
provided no such evidence.
[8]
On
January 14, 1999, Uppercut Software borrowed $50,000 from Fun Key on an
interest-free basis. The loan was repayable upon demand. Uppercut held shares
in Fun Key and did business with the company. The loan was for Uppercut's day-to-day
operations. To guarantee the repayment of the loan, Uppercut assigned 150,000
of its Fun Key Class A shares to Fun Key.
[9]
In
the same year, Uppercut did some development work on "Viewer"
software for Fun Key. Fun Key got six invoices from Uppercut, once invoice per
week, from August 16, 1999, to September 20, 1999. The
invoices totalled $28,800, plus $2,016 in GST and $2,113.20 in QST. In a letter
dated October 13, 1999, Mr. Langlois, of Uppercut, notified Fun Key's
representatives that the work that was to be performed had been ready since
September 25, 1999, and that they could pick up and verify the work at
Uppercut's office so that the problem could be laid to rest and Uppercut could
be paid in full for the work. Fun Key never took possession of the
"Viewer" software and never paid the invoices that it received from
Uppercut for the work. However, Uppercut made GST and QST remittances on
the invoices.
[10]
During
the same period, that is to say, in August and September 1999,
Uppercut's and Fun Key's lawyers exchanged letters following an August 26
meeting between their clients' representatives. The conflict at that time
was primarily about the new business structures, but the outcome was that Fun
Key asked for its $50,000 loan to be repaid in full, with interest, no later
than September 17, 1999. Uppercut never repaid the $50,000, and Fun
Key never sued for non-payment. In Uppercut's profit and loss statement
for the fiscal year ended February 28, 2002, the $50,000 debt to Fun
Key is still entered as a long-term liability.
[11]
However,
in Fun Key's profit and loss statements for the fiscal years ended
April 30, 1998, 1999, 2000 and 2001, the amount of the demand loan to
Uppercut Software is stated as a $50,000 receivable for the years 1999 and 2000.
In the 2001 statement, that receivable is reduced to $15,000, and in the 2002
statement, it is down to zero. On October 18, 2002, Fun Key made
an assignment of its assets for the benefit of its creditors under the Bankruptcy
and Insolvency Act. According to the auditor's report, Uppercut was
not listed as one of the creditors in Fun Key's bankruptcy.
[12]
As
for Uppercut, it wrote off Fun Key's debt as a bad debt on
February 28, 2001, on the basis that it did not have the means to sue
and that its relationship with Fun Key had deteriorated. Uppercut's liability
on the $50,000 loan was removed from its financial statements following Fun Key's
bankruptcy.
[13]
In
view of the above, the first issue to be determined is whether the cash
deposits into Uppercut Software's bank account constitute taxable supplies on
which the Appellant did not collect GST. One must also determine whether the
Respondent was entitled to assess penalties by reason of Uppercut's
failure to remit the GST to the Receiver General within the time allotted by
the ETA. The second issue for determination is whether Uppercut was entitled to
deduct $2,016 as a bad debt in computing its net tax on the invoices issued to Fun
Key.
[14]
It
is worth noting that, under subsection 299(1) of the ETA, the Minister is not bound by any return,
application or information provided by or on behalf of any person and may make
an assessment, notwithstanding any return, application or information so
provided or that no return, application or information has been provided. Moreover, under
subsection 299(3) of the ETA, an assessment is deemed valid unless it has been
vacated on an objection or appeal. The onus is therefore on Uppercut to show,
on a balance of probabilities, that the assessment is wrong.
[15]
The
auditor, using the bank deposits method, identified a large number of deposits
on which no GST was paid. In Uppercut's accounting, the corresponding entry in
the general ledger stated that the deposits were directors' "advances and
liabilities". Consequently, the auditor asked for supporting documents
showing that they were indeed advances made by the directors. Two of the
directors, whose advances were minimal, showed to the auditor's satisfaction
that the money used for the advances had been withdrawn from their personal
bank accounts. However, he did not receive such evidence from Alain Roy, the
third director, and therefore considered the deposits, which totalled
$44,311.40, to be taxable supplies on which Uppercut did not collect GST.
[16]
The
fact that these deposits were made in cash undoubtedly contributed to the
auditor's doubts as to the source of the funds. However, I must acknowledge that
Uppercut's accounting books identified these funds as advances from directors,
and that the advances are, in fact, entered on the two financial statements
that Uppercut tendered in evidence. The statement as at
February 28, 2002, says that Uppercut has a short-term liability of
$1,000 to Alain Roy. This advance is not actually one of the deposits covered
by the assessment. As far as the deposits covered by the assessment are
concerned, the financial statement as at February 28, 2002, lists a
short-term liability to Alain Roy in the amount of $32,311.40, and another such
liability in the amount of $3,350 to Francis Langlois.
[17]
Francis
Langlois is the only person who testified for Uppercut Software. All of
Alain Roy's deposits were identified; he is the person who made the most
deposits. Mr. Langlois apparently made one of the deposits after receiving
the money from Mr. Roy, and two deposits were apparently made by the third
director's wife.
[18]
Mr.
Langlois is an accountant, and he looks after the Appellant's books. In my
opinion, he testified forthrightly and honestly, and his credibility was never
put in question. He is unaware of the source of Mr. Roy's funds, but is certain
that the funds are not income earned by Uppercut for services rendered, and
that they are advances from Mr. Roy to Uppercut. He claims that Uppercut
carried on very little business as of the year 2000; the company was hardly
even in business, and had very few clients, hence the need to inject funds.
[19]
Alain
Roy could have been called as a witness in order to confirm Mr. Langlois'
assertions, but he was not. However, based on the evidence as a whole, I do not
believe that I can infer that his testimony would have been prejudicial to
Uppercut in that it would have shown that the deposited funds were unreported
income in Uppercut's hands on which GST was not remitted.
[20]
The
deposits are identified, the amounts are consistent with the accounting entries
for advances by directors, and, based on Uppercut's situation and activities
during the period and the testimony of Mr. Langlois in particular, I am
satisfied, on a balance of probabilities, that the amount of $44,311.40 was not
income that was received by Uppercut and on which GST was payable.
Naturally, in light of this finding, the penalties cannot be imposed on
these amounts.
[21]
Uppercut
also needs to show me, on balance of probabilities, that the Fun Key debt is a
bad debt and that it is entitled to deduct it in computing its net tax under
subsection 231(1) of the ETA.
[22]
The
Respondent claimed in her Reply to the Notice of Appeal that Uppercut was not
on the list of the creditors in Fun Key's bankruptcy, and this has been
admitted. Since Uppercut was not on the list, the Respondent determined that
the $50,000 loan and $33,127.20 debt had been set off against each other, and
that the Appellant was consequently not entitled to deduct the $2,016 as a bad
debt in computing its net tax.
[23]
However,
the evidence adduced discloses that, in September 1999, Fun Key, through
its lawyers, formally asked Uppercut's lawyers for the $50,000 loan to be repaid.
In addition, according to Fun Key's financial statements as at
April 30, 2001, Uppercut's debt was reduced to $15,000, and, in the
following year, the debt was down to zero, which would explain why Uppercut was
not one of the creditors in Fun Key's bankruptcy. According to Mr. Langlois,
Uppercut did not repay the loan to Fun Key, so it is likely that Fun Key used
its collateral, namely the shares, as repayment on the loan rather than setting
it off against the amount that it owed Uppercut. In my opinion, this is not at
all a situation in which it is suitable to apply the principles of compensation
set out in articles 1672 and 1673 of the Civil Code of Québec,
because the conditions that need to be met are not present, especially the
condition that the debts be certain. The fact that Fun Key could exercise
its rights under the guarantee makes it difficult to establish the amount of
the debt at a precise moment in time, and this means that the debt is uncertain.
[24]
In
my opinion, the true question is whether the debt was truly a bad debt, thereby
entitling Uppercut Software to deduct GST in the amount of $2,016 in computing
its net tax. The ETA provides no definition of "bad debt". However, based
on the case law and the provision itself, it is possible to draw up a list of
criteria that must be present in order for a deduction to be permitted under
subsection 231(1) of the ETA (see Ciriello v. The Queen, 98‑2304(GST)I,
November 30, 2000, and Davies v. The Queen, 97‑1983(GST)I,
May 29,1998):
1.
The supplier and recipient of the taxable supply must be at
arm's length from each other.
2.
The supplier initially reported and paid the tax
collectible.
3.
The debt is unrecoverable, in whole or in part.
4.
The supplier must have taken reasonable measures to collect
on the debt.
5.
The supplier wrote off the debt in its accounting records
at some point.
[25]
None
of the evidence that has been heard enables me to conclude that the Appellant
and Fun Key were not at arm's length from each other. The evidence
discloses that the tax was reported and remitted, and that the Appellant wrote
off the debt on February 28, 2001. It is also certain that the debt
became uncollectible by reason of Fun Key's assignment in bankruptcy on
October 18, 2002, a date that falls squarely within the period in
issue. As for the reasonable measures taken to collect on the debt, I am of the
opinion that, given the position that each party took in its correspondence,
the circumstances of the instant case leave no room to suggest any likelihood
that the amounts would be recovered. In fact, the Respondent never raised this
last point. Consequently, the Appellant is entitled to this input. The appeal
is allowed and the assessment is therefore vacated.
Signed at Fredericton, New Brunswick, this 13th day of
June 2008.
"François Angers"
Translation
certified true
on this 15th day
of October 2008.
Brian McCordick,
Translator
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