Citation: 2006TCC60
Date: 20060306
Docket: 2004-1670(GST)I
BETWEEN:
9022-8891 QUÉBEC INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
[OFFICIAL ENGLISH TRANSLATION]
REASONS FOR JUDGMENT
Paris J.
[1] The Appellant is a corporation that has been operating a restaurant, Le Maestro, located in St-Sauveur, Quebec, since 1995.
[2] In 2001, Quebec's Minister of Revenue (the "Minister") conducted an audit of the Appellant's business for the purposes of the Excise Tax Act (the "Act").[1]
[3] Following that audit, by a notice of reassessment dated November 21, 2001, covering the years ending July 31, 1997, 1998, 1999 and 2000, the Minister established the amounts payable by the Appellant as follows:
Net GST $135,971.03
Interest $19,042.77
Penalties[2] $55,752.13
[4] The Appellant disputes the assessment.
[5] The points at issue are:
- Was there a time bar under paragraph 298(1)(a) of the Act for the entire period concerned by the notice of reassessment?
- Did the Minister correctly compute the Appellant's taxable supplies for the period in issue?
- Was the Minister entitled to assess penalties under sections 280 and 285 of the Act in respect of the amounts of tax payable by the Appellant?
In its notice of appeal, the Appellant stated that it objected to the reduction of input tax credits ("ITCs") made by the Minister, but abandoned that position at the hearing.
[6] During the period in issue, the shareholders and directors of the Appellant were Sylvain Cormier and Éric Verpaelst. Messrs. Cormier and Verpaelst both took active roles in the restaurant's operations. Mr. Cormier managed the dining room, promotion and advertising, while Mr. Verpaelst ran the kitchen. The two shared the administration of the business, but Mr. Cormier stated that he had performed most of the responsibilities in that area.
[7] The establishment had a bar and approximately 100 seats in the dining room and employed approximately 12 or 13 persons.
The Audit
[8] Upon conducting an initial investigation, the Minister's auditor found that the Appellant's records were incomplete for the purposes of determining the amounts of GST that should have been collected by the Appellant.
[9] Among the problems that she noted with respect to the Appellant's records, she found that:
(i) in the sales reports provided by Mr. Cormier to the outside accountant, there were days when the total reported sales were less than the amount of sales paid by credit card and debit card;
(ii) the restaurant's total annual income figure differed, depending on whether it was stated in the financial statements, in the accountant's report, in the GST returns or in the report filed using the restaurant's computer; for 1999, the reported total varied from $449,718 to $486,616;
(iii) a lot of restaurant bills were missing.
The auditor concluded that she could not rely on the Appellant's records and therefore used an indirect audit method to reconstitute the Appellant's sales during the years in issue.
[10] First of all, the auditor broke down the alcohol purchases (beer, wine and spirits) made by the Appellant between August 1, 1996, and July 31, 2000, using, for that purpose, the invoices from the SAQ, Molson, Labatt and other suppliers that she found in the documents provided by the Appellant.
[11] Then she determined the selling price of beer by referring to the Appellant's menu and calculated the price mark-up percentages for wine and spirits.
[12] She applied the selling prices (beer) and mark-up rates (wine and spirits) to the Appellant's known purchases in order to establish the total income from the sale of these products in the context of the restaurant's operations in each of the years in issue. She then allowed a five percent reduction to acknowledge that a portion of the alcohol purchased would not have been sold, but would have been donated for promotional purposes, loss, used for cooking or consumed by staff.
[13] Once the auditor had established the beer, wine and spirits sales, she extrapolated in order to determine meal sales for each year. To do that, the auditor determined a ratio of alcohol sales to total sales for the restaurant for each year, which yielded the following percentages:
August 1, 1996, to July 31, 1997 34.46%
August 1, 1997, to July 31, 1998 35.19%
August 1, 1998, to July 31, 1999 36.59%
August 1, 1999, to July 31, 2000 42.82%
[14] By applying the relevant ratio to alcohol sales that she had calculated for each year, she arrived at total alcohol and meal sales and added to that figure the income received by the Appellant at golf tournaments it had organized each year. Total sales, according to the auditor, were:
August 1, 1996, to July 31, 1997 $789,756.21
August 1, 1997, to July 31, 1998 $928,393.18
August 1, 1998, to July 31, 1999 $1,089,557.10
August 1, 1999, to July 31, 2000 $1,022,528.39
According to the auditor's calculations, the Appellant failed to report sales totalling $1,899,075 for the four years in issue.
[15] The auditor also reduced the Appellant's ITCs by $3,017.97 and assessed, under sections 280 and 285 of the Act, penalties on the amounts of tax payable by the Appellant.
Appellant's Position
[16] In the instant case, the Appellant disputes certain assumptions used by the auditor in reconstituting the sales of the business. First, it states that the five percent margin allowed by the auditor to take into account alcohol purchased but not sold was too low and did not reflect the actual situation of the Appellant's operations. Second, it questions the ratio of alcohol sales to total sales used by the auditor.
[17] The Appellant also objects to the assessment of penalties and argues the ground that certain periods[3] covered by the assessment are time-barred.
Evidence
Alcohol Used for Promotional/Internal Use
[18] According to Mr. Cormier, there were a lot of restaurants in the St-Sauveur region, and competition was very strong. The restaurants in the area therefore engaged in various types of promotion. He said that he had tried to distinguish Le Maestro from its competitors through generous customer reception, using alcohol freely as a promotional tool. This was consistent with the atmosphere he wanted to create for the restaurant and the image he wanted to project to potential customers. He offered customers alcoholic beverages, or sometimes a bottle of wine, depending on the business they could bring to the restaurant. In the event of errors in service or problems arising during meals, he offered clients liqueurs or glasses of wine by way of compensation.
[19] He also testified that he had donated cases of beer to the St-Sauveur Festival of the Arts and to golf tournaments in exchange for advertising at those events. He said that, in total, he had donated approximately 50 cases of 24 beers to those events each year. In support of his statements, he filed three letters of acknowledgement: one from the Festival of the Arts for 10 cases of beer and a buffet provided by the restaurant, and two others, dated June 21 and July 30, 2000, thanking him for 10 cases of beer donated to two golf tournaments.
[20] Mr. Cormier also stated that Le Maestro allowed employees to have one or two beers or wine at the end of their shift and that two bottles of wine a week were drunk during wine tastings given to familiarize waiters with the new items on the wine menu. Two more bottles of wine were drunk each week by Mr. Cormier and Mr. Verpaelst with business meals that they took at the restaurant. Lastly, he stated that Le Maestro had often offered alcoholic beverages to friends and clients who stopped by the restaurant in the afternoons before it opened its doors.
[21] Mr. Cormier's testimony that Le Maestro regularly offered beer, wine or spirits to welcome clients was confirmed by two regular customers of the restaurant, Pierre Audette and Michel Gauthier.
[22] In addition, Isabelle Lord, a member of the St-Sauveur Chamber of Commerce during the years in issue, testified that Mr. Cormier had provided pre-meal drinks and wine at familiarization luncheons that the Chamber of Commerce organized for the concierges of the major Montréal hotels and for event planners, also from Montreal, who had been taken to St-Sauveur to familiarize them with the area. Ms. Lord said that there were no documents related to those visits, that she had arranged everything by telephone.
[23] Another witness, Gaétan Poitras, a former employee of Le Maestro restaurant, testified that, at the end of each shift, employees, normally five to 10 of them, stayed behind and drank at the bar free of charge.
Ratio of Alcohol Sales to Total Sales
[24] Mr. Verpaelst, the restaurant's chef, presented his calculations of the quantity of alcohol used in the kitchen during the years in issue. He specified the types and quantities of alcohol used in the kitchen each week, depending on the dishes offered on the menu. Kitchen use included beer, wine, and spirits.
[25] With respect to the calculation of the alcohol sales/total sales ratio, Mr. Cormier emphasized that the results of the audit could not stand because, according to them, Le Maestro had a cost of sales/total income ratio of only 25 percent. Mr. Cormier pointed out that the reported income of Le Maestro restaurant indicated a cost of sales/total income ratio of 45 percent, which, in his view, would be more reasonable.
[26] In cross-examination, the auditor stated that, based on her experience, a restaurant of the same kind as Le Maestro would have a cost of sales/revenue ratio of between 30 percent and 35 percent, but that that varied from one establishment to another.
Bartering
[27] Mr. Cormier also testified that he had made arrangements that he called contracts of exchange with certain businesses, arrangements whereby Le Maestro exchanged meals at the restaurant, including alcoholic beverages, for radio advertising, sound equipment, table and kitchen linen and advertising relating to a television series. On this point, he filed exchange contracts worth $77,752.84. He also stated that he had had other contracts for the periods in issue, but he did not file them with the Court. He stated that there were other exchange contracts in the boxes of documents he had provided to the auditor.
[28] And yet the auditor stated that she had not seen any documents concerning bartering arrangements at the time of the audit.
Accountant's Testimony
[29] The Appellant also called as a witness the Appellant's current accountant, Luc Bergeron, who revealed that his services had not been retained until July 31, 2002. The essential part of his testimony concerned a table that he had prepared to establish the quantity of alcohol purchased by the Appellant that was not resold during its operations and to quantify the reduction in the assessment that the Appellant was seeking. Mr. Bergeron relied on the information provided by Mr. Cormier and Mr. Verpaelst in preparing the table and had no personal knowledge of the figures. The table is of little probative value, since most of the figures Mr. Bergeron used were not corroborated by Mr. Cormier in his testimony.
[30] It should be noted that Mr. Bergeron calculated in the table that, of the 11,996 bottles of beer purchased by the Appellant between August 1, 1996, and July 31, 1997, 8,942 were either given away or used in the kitchen, and only 3,054 were sold by the Appellant. According to the table, the situation was essentially the same for the other years in issue.
Arguments
[31] Counsel for the Appellant claimed that he had made a prima facie case demolishing the assumptions made by the Respondent in reconstituting the Appellant's sales. He relied on the decisions in First Fund Genesis Corporation,Karmin, Chomica, MacIsaac, Zink and Hickman Motors[4] and contended that the failure to discharge the obligation under subsection 286(1) of the Act to keep accurate records nevertheless does not give the Minister free rein to use arbitrary assumptions in making an assessment. An Appellant can, by making a prima facie case, demolish the assumptions on which the Respondent relies, as L'Heureux-Dubé J. wrote in Hickman Motors, at paragraphs 92 and 93:
[...] The Minister, in making assessments, proceeds on assumptions [...] and the initial onus is on the taxpayer to "demolish" the assumptions in the assessment [...] The initial burden is only to "demolish" the exact assumptions made by the Minister but no more [...]
This initial onus of "demolishing" the Minister's exact assumptions is met where the Appellant makes out at least a prima facie case [...]
[32] In the instant case, the Appellant claims that it has demolished the assumptions made by the Minister: first, that all the alcohol purchased by the Appellant was sold, except for the five percent used for promotions, used in the kitchen and consumed by staff. Counsel for the Appellant cited the decision by this Court in Gestion Cheers Inc. v. Canada, [2001] T.C.J. No. 179 (QL), 2001 G.T.C. 377, which concerned alleged sales made in the operation of a bar and not reported. In that case, the auditor had determined that 10 percent of total sales of alcoholic beverages had been lost in spillage and used for promotion, whereas the Appellant claimed that it was closer to 30 percent. The Court allowed the appeal, having accepted the testimony of the principal of the Appellant as sufficient prima facie evidence to discharge the burden of proof. Counsel for the Appellant in the instant case contends that Mr. Cormier's testimony should also be accepted as prima facie evidence and that the Respondent should discharge the burden of proof.
[33] Second, the Appellant claims that it demolished the Respondent's assumption that alcohol sales were necessarily related to the sale of meals and represented 34.46 percent of total sales.
[34] Counsel for the Appellant alleges that alcohol could have been sold without meals. According to the Appellant's reasoning, the Minister's assumptions must be incorrect, since, based on that assumption, the restaurant's total income would yield a ratio of the Appellant's cost of sales to total sales of only 25 percent, which would be too low.
[35] In his argument on the margin allowed by the auditor for unsold alcohol, counsel for the Appellant raised the question of how the exchange contracts between the Appellant and some of its suppliers should be treated. The auditor was not aware of those arrangements at the time of the audit.
[36] As to the penalties, the Appellant argued in its defence that it had exercised due diligence, relying on the following passages of the reasons of Décary and Létourneau JJ. in Corporation de l'école polytechnique v. Canada,2004 FCA 127:
[28] The due diligence defence allows a person to avoid the imposition of a penalty if he or she presents evidence that he or she was not negligent. It involves considering whether the person believed on reasonable grounds in a non-existent state of facts which, if it had existed, would have made his or her act or omission innocent, or whether he or she took all reasonable precautions to avoid the event leading to imposition of the penalty. See The Queen v. Sault Ste-Marie, [1978] 2 S.C.R. 1299; The Queen v. Chapin, [1979] 2 S.C.R. 121. In other words, due diligence excuses either a reasonable error of fact, or the taking of reasonable precautions to comply with the Act.
[37] On this subject, counsel for the Appellant stated:
[TRANSLATION]
In the instant case, what we contend is that the Appellant's representative believed, perhaps incorrectly, that he had reported all the taxable sales of the business because he said: "I give away a lot of beer or alcohol for promotional purposes." And that is probably... if that is not the case, that means it is nevertheless reasonable in the circumstances because he did not even have any accurate records enabling him to meet his obligations.
[38] With respect to the penalty assessed under section 285 of the Act, counsel for the Appellant relied on the decision in 410812 Ontario Ltd. v. The Queen, in which Associate Chief Justice Bowman (as he then was) stated:
[9] If any broad principle can be deduced from the multiplicity of cases decided under subsection 163(2) of the Income Tax Act, it is that courts are reluctant to sanction the imposition of gross negligence penalties unless evidence of a high degree of negligence is clearly established.
According to counsel for the Appellant, the Respondent did not demonstrate the required degree of negligence to warrant the penalty.
Analysis
[39] Through the testimony of Sylvain Cormier, Pierre Audette, Michel Gauthier and Isabelle Lord, the Appellant showed that the use of alcohol for promotional purposes was a common practice in the restaurant's operation. However, the Appellant's position was weaker on the question of the quantities used in that manner. For that reason, I could not characterize the aforementioned testimony as establishing a prima facie case. Although Mr. Cormier provided some figures on the quantities of alcohol the Appellant had used for promotional purposes, there was very little corroboration of his statements. He filed only three documents concerning beer donations in exchange for advertising. The testimony of the other witnesses concerning promotion consisted of anecdotes and does not provide a basis for specifying the quantity of alcohol used for that purpose.
[40] On the other hand, the evidence of the use of alcohol in the kitchen was more substantiated, and the witness, Mr. Verpaelst, did not contradict himself in cross-examination. The Appellant was thus able to prove a significant consumption in this aspect of its operations.
[41] On the whole of the evidence, I assume that the Appellant donated approximately 40 cases of beer a year to various golf tournaments or festivals, and that the internal consumption of wine, beer and spirits was significant. I also assume that the Appellant offered beer, wine and spirits free of charge to the restaurant's customers and employees.
[42] Although it is difficult to attach a specific margin to those quantities, I am satisfied that the margin of five percent of all the alcohol purchased by the Appellant allowed by the auditor for promotion and internal use should be increased to 15 percent to take these factors into account. I am also convinced that the Appellant did not demonstrate that the margin was greater than 15 percent.
[43] With respect to the decision in Gestion Cheers cited by the Appellant, I would note that, although the Court found that the testimony of the principal had not been corroborated, the latter had nevertheless in fact produced a book attesting to the actual situation regarding the promotional activities carried out by the bar, and the Court accepted it as substantiating his testimony.
Ratio
[44] The Appellant was unable to bring convincing evidence of what a reasonable cost of sales/total sales ratio would be for a restaurant like that of the Appellant. Neither Mr. Cormier nor Ms. Morand, the auditor, was qualified to give expert evidence on that point, and their testimony was a matter of conjecture. Consequently, the Appellant did not show that the auditor had erred in computing the Appellant's alcohol sales/total sales ratios for each year in issue. For that reason, the Appellant's second argument is rejected.
Bartering
[45] Under subsection 153(3) of the Act, the value of exchanges between registrants is not subject to GST and no ITCs may be claimed in respect thereof. In the Appellant's case, it would appear that the quantity of alcohol consumed by the persons with whom the Appellant made the exchanges was included in the quantities the auditor had assumed had been sold as part of the Appellant's operations. The auditor, in calculating food sales, also apparently calculated an amount for food that corresponded to the amount of alcohol consumed by the other party to the exchange agreement.
[46] Having regard to subsection 153(3), it is clear that alcoholic beverages consumed and meals taken in such circumstances are not taxable. The Appellant is therefore entitled to a reduction of total sales established by the Respondent corresponding to the amount of the exchange contracts.
[47] The Appellant filed contracts of a value of $78,550 for the period from August 1, 1999, to July 31, 2000. Mr. Cormier's testimony that there were other contracts of that kind remains vague and uncorroborated, and I am not prepared to allow the Appellant a reduction above that amount. The reduction in the restaurant's total sales will be $78,550 for the period from August 1, 1999, to July 31, 2000.
Penalties
[48] Subsection 280(1) of the Act provides for a strict liability penalty:
280.(1) 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.
The Respondent also demonstrated significant deficiencies in the Appellant's records and established by means of a detailed audit method that substantial sales were not reported.
[49] The Appellant claims that it exercised due diligence, but its argument amounts to saying that it should not have to pay penalties on unreported sales, because it relied on the records that it itself had poorly kept. And yet it is clear that the Appellant's negligence in keeping its records cannot protect it.
[50] Ultimately, the Appellant brought no evidence that its directors or officers exercised due diligence to keep the necessary records so as to prevent errors in its GST returns. Mr. Cormier did not state what precautions had been taken by him or other persons to avoid those errors. Furthermore, the accountant who worked for the Appellant at the time was not called as a witness.
[51] The 25 percent penalty provided for under section 285 requires a considerably higher degree of negligence than section 280. Unlike section 280, which provides for a strict liability penalty, section 285 provides that a penalty shall be assessed in respect of a person who "knowingly, or under circumstances amounting to gross negligence, makes [...] a false statement or omission in a return."
[52] The burden of proof under this provision is on the Respondent. Without having to prove mens rea, she must nevertheless discharge a heavy civil burden of proof on a balance of probabilities, as Strayer J. wrote in Venne v. Canada (M.N.R.), [1984] F.C.J. No. 314 (QL) (which concerned a penalty assessed under subsection 163(2) of the Income Tax Act, which is the counterpart of section 285 of the Excise Tax Act):
[...]By virtue of subsection 163(3) "the burden of establishing the facts justifying the assessment of the penalty is on the Minister". It will be noted that for the penalty to be applicable there appears to be a higher degree of culpability required, involving either actual knowledge or gross negligence, than is the case under subsection 152(4) for reopening assessments more than four years old where mere negligence seems to be sufficient.
[53] As Bowman J. (as he then was) stated in Farm Business Consultants Inc. v. Canada, [1994] T.C.J. No. 760 (QL), paragraph 27, 95 DTC 200, at pages 205 and 206:
A court must be extremely cautious in sanctioning the imposition of penalties under subsection 163(2). Conduct that warrants reopening a statute-barred year does not automatically justify a penalty and the routine imposition of penalties by the Minister is to be discouraged. Conduct of the type contemplated in paragraph 152(4)(a)(i) may in some circumstances also be used as the basis of a penalty under subsection 163(2), which involves the penalizing of conduct that requires a higher degree of reprehensibility. In such a case a court must, even in applying a civil standard of proof, scrutinize the evidence with great care and look for a higher degree of probability than would be expected where allegations of a less serious nature are sought to be established. Moreover, where a penalty is imposed under subsection 163(2) although a civil standard of proof is required, if a taxpayer's conduct is consistent with two viable and reasonable hypotheses, one justifying the penalty and one not, the benefit of the doubt must be given to the taxpayer and the penalty must be deleted. I think that in this case the required degree of probability has been established by the Respondent, and that no hypothesis that is inconsistent with that advanced by the Respondent is sustainable on the basis of the evidence adduced.
[54] The facts in the instant case reveal a high degree of negligence in the Appellant that would warrant the assessment of a penalty provided for under section 285.
[55] The evidence shows major and repeated omissions in the GST returns, that is unreported sales of more than $1 million out of total sales of approximately $3.5 million over four years. The evidence also shows incomplete bookkeeping.
[56] In 410812 Ontario Ltd., supra, the taxpayer succeeded in having the penalties cancelled by providing an explanation of the omissions in its GST returns that did not involve obvious negligence. Bowman J. found that the taxpayer was entitled to the benefit of the doubt.
[57] In the instant case, the Appellant did not provide any explanation of its omissions, and the only conclusion that I can reach is that they were the result of obvious negligence on its part.
[58] In view of the specific circumstances of this case, the Appellant's negligence in disclosing its financial statements is such that it is tantamount to gross negligence.
[59] Having regard to my decision that the omissions in the Appellant's GST returns resulted from gross negligence, it goes without saying that the time bar provided for in section 298 of the Act does not prevent the Minister from assessing for the periods in 1996 and 1997.
[60] For all these reasons, the appeal shall be allowed, on the basis that:
- the margin of five percent of all alcohol purchased by the Appellant for promotion and internal use should be increased to 15 percent;
- the Appellant is entitled to a reduction of its total sales corresponding to the amount of the exchange contracts, that is $78,550, for the period from August 1, 1999, to July 31, 2000; and
- the penalties and interest shall be adjusted accordingly.
Signed at Ottawa, Ontario, this 6th day of March 2006.
"B. Paris"
Translation certified true
on this 8th day of August 2006.
J. Poirier, Translator
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