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Citation: 2004TCC727
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Date: 20041130
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Docket: 2000-2619(IT)G
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BETWEEN:
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TROM ELECTRIC CO. LTD.,
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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
Paris,J.
[1] The Appellant is an electrical
contractor and has been in business for approximately 25 years in
the Toronto area. By its own admission, it made certain errors in
reporting its income in years including its 1989 to 1994 taxation
years. More particularly, the Appellant made mistakes in how it
treated construction lien holdbacks that it could not collect
from its customers until the expiry of a set period after the
work for the customer had been completed. The Appellant deducted
holdbacks owing to it at its year end and included those amounts
back into income the following year.
[2] The errors in question came to the
attention of the Minister of National Revenue (the
"Minister") in 1995, by which point the Appellant's
taxation years up to 1991 had become statute-barred.
[3] The Minister reassessed the
Appellant for the 1992, 1993 and 1994 taxation years to correct
the errors. For the 1993 and 1994 taxation years the Minister
reversed both the deduction of the holdbacks and the inclusion of
the previous years' holdbacks into income. However, for the
1992 taxation year he reversed only the deduction of the
holdbacks. The previous year's holdback deduction that the
Appellant had erroneously included in income in 1992 totalling
$533,870 was left in income. The Minister says that the Appellant
is estopped from now claiming that the amount was not properly
included in its income in that year.
[4] Although the Appellant has
appealed from the reassessments of its 1992, 1993 and 1994
taxation years, the dispute centres on the reassessment of its
1992 taxation year. The Appellant says that the Minister is
obliged to reassess to remove the amounts of the holdbacks from
1991 that the Appellant had mistakenly included in income in
1992. In the alternative, the Appellant says that if the Minister
is not required to reverse the 1992 inclusion, he should not be
permitted to reverse any of the holdback deductions and
inclusions originally reported by the Appellant, and all of the
years under appeal should be reassessed accordingly.
[5] The main issue before the Court is
whether the doctrine of estoppel is applicable in the
circumstances of this case. For the reasons that follow, I find
that it is not. In light of this finding, it is not necessary for
me to address the Appellant's alternative argument.
Background
[6] The holdbacks in issue arise under
the Construction Lien Act[1], which requires that a customer under
a construction contract hold back 10% of the amounts that are
payable under the contract until 45 days after the contract has
been completed or until substantial completion has been
certified. Before the expiry of the holdback period any person
who has supplied services or materials under the contract who has
not been paid can register a lien against the property on which
the work was performed. The holdbacks therefore provide
protection to subcontractors and suppliers for payments that are
due to them by the contractor.
[7] As indicated above, the Appellant,
by its own admission, failed to account correctly for the
holdbacks which were receivable at the end of its 1989 to
1994 taxation years.
Evidence
[8] It was not clear what led to the
Appellant's mistaken treatment of the holdbacks. The evidence
shows that the Appellant's accounting was quite disorganized up
until about 1994. The company changed accountants near the end of
1991, and it filed amended tax returns for its 1989 to 1991
taxation years showing adjustments to sales, cost of sales,
unbilled revenue and work in progress accounts. The Appellant's
new accountants made an adjustment to the opening retained
earnings in its financial statements in 1992 to correct a number
of accounting errors, including errors in the recognition of
revenue and expenses on contracts in progress.[2] Further material corrections to
prior periods were made by the accountants in the Appellant's
1994 financial statements which contained the following
statement:
A series of accounting errors occurred in 1991 and prior which
were previously recorded as prior period adjustments. In
addition, in the current year, errors made in the calculation of
the percentage of completion method of revenue recognition
throughout the period 1989 to 1993 were also identified. The
financial statements have been adjusted retroactively for the
years 1991 and prior, 1992 and 1993 to correct these errors, and
to record the related income tax consequences.[3]
[9] It is clear that the errors made
by the Appellant with respect to the holdbacks was not detected
at the time the amended returns for the 1989 to
1991 taxation years were filed or during the audit of those
returns by the Minister. In fact, the error was only discovered
in 1995 in the course of the audit of the Appellant's 1992 and
1993 taxation years. The evidence showed that the Appellant's
1991 taxation year was initially assessed on September 6,
1991 and therefore it became statute barred on September 6, 1994.
[10] The Appellant and the Respondent each
called an accounting expert to give evidence of how income from
construction contracts is computed according to generally
accepted accounting principles (GAAP). Both experts agreed that
under GAAP there were two methods available to construction
contractors for calculating income: the percentage of completion
method and the completed contract method.
[11] Essentially, the percentage completion
method recognizes a portion of profit from construction contracts
at the end of each fiscal period during which the contracts are
ongoing. The portion of profit that is included in income for the
fiscal period is based on the percentage of the job that is
complete at the time, after deducting certain amounts not
considered "receivable" at the fiscal period end. In
contrast, the completed contract method does not recognize any
profit from the contract until the end of the fiscal period in
which the job is completed.
[12] In its financial statements the
Appellant used the percentage of completion method of accounting
for reporting its income. In reporting income for tax purposes
the Appellant used the completed contract method of accounting[4], which the
Minister permits a taxpayer to do where the contracts of which
the taxpayer worked may reasonably be expected to be completed
within two years from the date of their commencement[5]. It was admitted by the
Respondent that the Appellant was entitled to report its income
this way.
[13] In order to arrive at income for tax
purposes (and ostensibly in order to convert from the percentage
of completion method of accounting to the completed contract
method) the Appellant made certain adjustments to the income
shown on its financial statements. These adjustments included
deducting holdbacks outstanding at the year end, and including
the holdbacks that had been deducted at the previous year
end. This is the point at which the errors in issue
arose.
[14] Both experts testified that these
adjustments for the holdbacks were made in error and that the
completed contract method of accounting does not permit the
deduction of holdbacks that are outstanding at the year end in
determining income. The Appellant therefore does not dispute that
it was not entitled to deduct the holdbacks owing to it at each
year end in the calculation of its income for tax purposes.
[15] The Respondent's expert indicated in
his report that under GAAP the error in deducting the holdbacks
would be corrected retroactively, restating all prior years' net
incomes. The specific steps required to correct the error were
set out as follows:
1. Increase
the current fiscal-year's income by adding back the current
year's holdback deduction that was erroneously taken.
2. Reduce the
current fiscal-year's income by deducting the prior fiscal-year's
holdback deduction, which would have erroneously increased this
year's income when the holdback conditions were resolved.[6]
[16] The Appellant's expert concurred that
the errors relating to the holdbacks should be corrected by
reversing the deductions and inclusions in all years. He
indicated that for a taxpayer using the completed contract method
of accounting, the deduction of the holdbacks receivable in one
year and their inclusion in income in the second year would
result in an understatement of profit in the first year and an
overstatement of income in the second year.
Position of the Parties
[17] The Respondent does not take issue with the proposition
that, for a taxpayer using the completed contract method of
accounting for income tax purposes, no deduction for outstanding
holdbacks can be taken, and that corresponding inclusions of
those holdbacks in income the following year is contrary to
GAAP.
[18] The Respondent says, however, that the
Appellant is now estopped from claiming that the 1991 holdback
deduction was wrongly taken in 1991 and that those holdbacks were
wrongly added back to income in its 1992 taxation year. The
elements of estoppel, being representation, reliance and
detriment, have been proved: the Appellant made a representation
in its 1992 tax return by including the holdbacks outstanding at
the end of 1991 as income in its 1992 tax return, the Minister
relied on the representation in reassessing the amount as income
in the Appellant's 1992 taxation year, and this reliance was
to the Minister's detriment because the year in which the amount
should have been reported (i.e. 1991) is now statute barred.
Counsel says that if the reassessment before the Court is not
upheld, the Appellant will escape taxation on the amount of the
holdback deduction taken in 1991 because the Minister cannot
reassess to add it back into the Appellant's income for 1991.
[19] The Appellant argues that estoppel does
not lie in this case because the Appellant's representation of
its income was a representation of law. He cites the
Supreme Court of Canada decision in Canderel Ltd. v.
The Queen[7] as
authority for the proposition that the determination of a
taxpayer's income under the Income Tax Act is a matter of
law. He says that the errors made by the Appellant in reporting
its income in 1992 must be corrected by reversing both the
deduction of the holdback reserve and the inclusion of the
previous year's holdback reserve. The Minister is not permitted
to reverse one without the other simply because the
1991 year has become statute barred. He says that the
determination of income is made on a year by year basis, and that
it is not in accordance with the Act or GAAP to include
the 1991 reserve in income in 1992.
Analysis
[20] Counsel for the Appellant relies on the
decision of the Federal Court Trial Division in The Queen v.
Wilchar Construction Limited[8] in support of the proposition that the Appellant
is estopped from taking the position that the holdbacks deducted
in 1991 should not be included in its income for its
1992 taxation year.
[21] In Wilchar Construction
the taxpayer had reported its income each year from construction
contracts by including certain amounts that were contingently
receivable at its year end. The taxpayer had consistently
reported its income on this basis, but sought later to have the
receivables excluded from income in the year in which they were
originally included. The taxpayer alleged that according to GAAP
and tax jurisprudence the amounts in question did not constitute
income for tax purposes in the year in which they were reported
and therefore the Minister should be required to reassess to
remove them from income. The Minister refused. After the taxpayer
commenced its appeal of that reassessment, it also sought to
exclude other receivables from income on the same basis as the
amounts originally put in issue. By that point the year in which
the taxpayer alleged these new amounts should have been included
in income had become statute barred.
[22] The trial judge found that the taxpayer
had the option of reporting the receivables either in the year
they became receivable or the year in which they were actually
received. Either method of accounting for them would have been
acceptable under the Income Tax Act. He went on to find
that the taxpayer had not "discharged the onus on it of
proving that the application of different acceptable methods to
successive fiscal periods accords with generally accepted
accounting principles." Therefore, on the basis that the
taxpayer's original method of reporting its income to include
those amounts were legally correct, he upheld the
reassessments.
[23] The trial judge also dealt, in
obiter, with the question of whether the taxpayer was
estopped from seeking to change its method of reporting income.
He found the taxpayer was estopped, because it had made
representations as to its profits for the year in question
"by the consistent way in which it calculated them" and
the Minister acted on those representations, and would suffer a
detriment if the taxpayer were permitted to deny those
representations.
[24] The Court of Appeal upheld the trial
judge's findings, and stated that there was no legal bar to
estoppel because the original method of accounting followed by
the taxpayer in reporting its income was not contrary to law.[9] It can be inferred
that, had the method chosen by the taxpayer resulted in a
representation of his income that was not in accordance with the
Act, and thereby contrary to the law, estoppel would not
have arisen.
[25] In the case before me I find that the
Appellant's calculation of its income in its 1992 tax return was
not made in accordance with the provisions of the Income
Tax Act and specifically with section 9 of the
Act, which requires the determination of an accurate picture of a
taxpayer's profit. It is admitted by the Respondent that the
profit reported by the Appellant for 1992 was not accurate. The
inaccuracy arose because the Appellant made adjustments to its
income (in the form of the holdback deductions and inclusions)
that were not in accordance with the method of accounting it was
using to determine its profit.
[26] The question of whether an amount must
be included in or can be deducted from income in the
determination of profit under the Income Tax Act is
clearly a question of law; it involves an interpretation of the
provisions of the Act and the legal principles established
by the jurisprudence. Therefore, a representation by a taxpayer
of his income involves interpretations of law. In Goldstein v.
Canada, Bowman, A.C.J. reviewed the question of estoppel in
relation to representations of law and made the following
comments:
...Although estoppel is now a principle of substantive law it
had its origins in the law of evidence and as such relates to
representations of fact. It has no role to play where questions
of interpretation of the law are involved, because estoppels
cannot override the law...
...[C]ourts, who have an obligation to decide cases in
accordance with the law, are not bound by representations,
opinions or admissions on the law expressed or made by the
parties.[10]
The rule that estoppel cannot override the law is applicable
in this case. Since the Minister's reassessment of the Appellant
is contrary to law the Appellant cannot be estopped from
challenging it.
[27] The fact that the Appellant may escape
taxation on the amount in issue in this appeal unless the
reassessment is upheld is not relevant. It cannot be used as a
justification for a reassessment that the Minister does not have
the power to make under the Income Tax Act. In another
case on this point, Dussault J. stated:
The Minister has no power to assess a taxpayer in the year of
his choice when he did not do so for the year in which he was
required to do it under specific legislative rules. Allowing him
to do this would be to give him a legislative power or discretion
which he does not have.[11]
[28] Furthermore, the Appellant would only
escape taxation on this amount through operation of the Income
Tax Act, if the limits placed on reassessments in
subsection 152(4) are applicable to the Appellant's 1991 taxation
year, or if the Minister chooses not to reassess for that
year.
[29] In summary, the Appellant is not
estopped from claiming that the holdbacks outstanding at the end
of its 1991 taxation year were wrongly included in income in its
1992 taxation year, and the Minister is ordered to reassess the
Appellant's 1992 taxation year to remove that amount
from income. The appeal is therefore allowed with costs.
Signed at Ottawa, Canada, this 30th day of November 2004.
Paris, J.
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