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Citation: 2004TCC728
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Date: 20041108
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Docket: 2002-2638(IT)G
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BETWEEN:
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CHARTWELL MANAGEMENT INC.,
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Appellant,
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and
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HER MAJESTY THE QUEEN,
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Respondent,
Docket: 2002-2639(IT)G
AND BETWEEN:
CENTUS INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
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Appeals heard on October 18 and 19, 2004 at
Saskatoon, Saskatchewan
REASONS FOR JUDGMENT
Beaubier, J.
[1] These appeals pursuant to the
General Procedure were heard together on common evidence at
Saskatoon, Saskatchewan on October 18 and 19, 2004.
[2] The Appellants called Joseph
Donlevy, B.A., M.B.A., the operating officer and director of the
Chartwell Management Inc. ("Chartwell") at all material
times; Douglas Konkin, B.Eng., M.Sc., P.Eng., the officer and
operator of Centus Inc. ("Centus") at all material
times; and Thomas Zurowski, C.A., a partner of KPMG, LLP., which
was the accounting firm of Hypercore Technology Inc.,
("Hypercore"), and Chartwell at all material times. The
Respondent called Bonnie Lindgren the Canada Revenue Agency
officer in charge of the Appellants' reassessments.
[3] Paragraphs 6 to 23 of the Reply to
Chartwell's Notice of Appeal outline the matters in issue in
these appeals for the years 1995, 1996 and 1997. They read:
6. With
respect to paragraph 10 of the Notice of Appeal, he admits that
the Appellant provided management services and equipment rentals
to Hypercore for consideration totaling $13,268.00 in the 1995
fiscal period (the "1995 fee") but he has no knowledge
of whether or not the fee was paid in the 1995 fiscal period and
therefore does not admit that the Appellant was not paid the
above noted amount as at December 31, 1995.
7. With
respect to paragraphs 11, 17 and 23 of the Notice of Appeal, he
admits that KPMG Chartered Accountants ("KPMG")
prepared the Appellant's financial statements and income tax
returns for the 1995, 1996 and 1997 fiscal periods, however, for
greater certainty, he states that the financial statements and
income tax returns were prepared based on information provided by
the Appellant. He has no knowledge of the remaining allegations
of fact contained in the above noted paragraphs and puts the
Appellant to the strict proof thereof.
8. With
respect to paragraphs 12, 18 and 24 of the Notice of Appeal, he
admits that KPMG prepared the Appellant's financial
statements and income tax returns for the 1995, 1996 and 1997
fiscal periods and that the amounts that the Appellant invoiced
Hypercore were not included in the Appellant's financial
statements or income tax returns. However, for greater certainty,
he states that the above noted amounts were also not recorded in
the Appellant's books and records. He has no knowledge of the
remaining allegations of fact contained in the above noted
paragraphs and puts the Appellant to the strict proof
thereof.
9. With
respect to paragraph 16 of the Notice of Appeal, he admits that
the Appellant provided management services and equipment rentals
to Hypercore for consideration totaling $60,015.00 in the 1996
fiscal period (the "1996 fee") but he has no knowledge
of whether or not the fee was paid in the 1996 fiscal period and
therefore does not admit that the Appellant was not paid either
the 1995 or the 1996 fee as at December 31, 1996.
10. With respect to
paragraph 22 of the Notice of Appeal, he admits that the
Appellant provided management services and equipment rentals to
Hypercore for consideration totaling $54,624.00 in the 1997
fiscal period (the "1997 fee") but he has no knowledge
of whether or not the fee was paid in the 1997 fiscal period and
therefore does not admit that the Appellant was not paid the 1995
fee, the 1996 fee or the 1997 fee as at December 31, 1997.
11. With respect to
paragraph 29 of the Notice of Appeal, he admits that Develcon
Electronics Ltd. ("Develcon") offered to purchase all
of the outstanding shares in Hypercore, however, he has no
knowledge of the remaining allegations of fact contained therein
and puts the Appellant to the strict proof thereof.
12. With respect to
paragraph 32 of the Notice of Appeal, he admits that Develcon
purchased all of the outstanding shares in Hypercore, however, he
has no knowledge of the remaining allegations of fact contained
therein and puts the Appellant to the strict proof thereof.
13. The Appellant reported
the following amounts on its T2 income tax returns for the 1995,
1996 and 1997 taxation years:
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1995
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1996
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1997
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Taxable Income
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$46,635.00
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$28,921.00
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$167,840.00
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Federal Income Taxes - Part I
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$5,705.49
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$3,795.00
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$29,675.00
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14. The Minister of
National Revenue (the "Minister") initially assessed
the Appellant for the 1995 taxation year on September 30,
1996.
15. The Minister initially
assessed the Appellant for the 1996 taxation year on August 18,
1997.
16. The Minister initially
assessed the Appellant for the 1997 taxation year on September
28, 1998.
17. In computing its
income for the 1995 taxation year the Appellant failed to include
income earned totaling $13,268.00. In reassessing the Appellant
for the 1995 taxation year the Minister added $13,268.00 to the
Appellant's income. The Minister also assessed penalties in
the 1995 taxation year pursuant to subsection 163(2) of the
Act.
18. In computing its
income for the 1996 taxation year the Appellant failed to include
income earned totaling $60,015.00. In reassessing the Appellant
for the 1996 taxation year the Minister added $60,015.00 to the
Appellant's income. The Minister also assessed penalties in
the 1996 taxation year pursuant to subsection 163(2) of the
Act.
19. In computing income
for the 1997 taxation year the Appellant failed to include income
earned totaling $54,624.00. In reassessing the Appellant for the
1997 taxation year the Minister added $54,624.00 to the
Appellant's income. The Minister also assessed penalties in
the 1997 taxation year pursuant to subsection 163(2) of the
Act.
20. The Minister issued
Notices of Reassessment for the Appellant's 1995, 1996 and
1997 taxation years on July 27, 2000.
21. In so reassessing the
Appellant for the 1995, 1996 and 1997 taxation years, the
Minister relied on, inter alia, the following
assumptions:
a) The
Appellant is a corporation incorporated under The
Business Corporations Act of Alberta that is
extra-provincially registered under the Business Corporations
Act of Saskatchewan;
b) At all
relevant times, the Appellant carried on business in the Province
of Saskatchewan which consisted of consulting, management
services and equipment rentals;
c) At all
relevant times, Martin Joseph Donlevy owned 50% and Claire
Donlevy owned 50% of the issued and outstanding Class
"A" shares in the capital of the Appellant;
d) At all
relevant times, Martin Joseph Donlevy was also known as Joe or
Joseph Donlevy.
e) At all
relevant times, Joseph Donlevy was a director and held the office
of secretary-treasurer of the Appellant;
f) At
all relevant times, Joseph Donlevy was a shareholder of
Hypercore;
g) At all
relevant times, Joseph Donlevy was a director and held the office
of president of Hypercore;
h) Joseph
Donlevy managed Hypercore for the three years at issue and until
the shares were sold to Develcon Electronics Ltd.
("Develcon") and he was responsible for the financial
management of Hypercore, which included finding additional
capital, applying for grants from CANARIE and applying for
Scientific Research and Experimental Development
("SRED") claims;
i) At
all relevant times, Hypercore carried on business in the Province
of Saskatchewan consisting of scientific research and
development;
j)
During the 1995, 1996 and 1997 taxation years, the Appellant
provided management services and computer equipment rentals to
Hypercore;
k) During the
1995 taxation year the Appellant earned at least $13,268.00 from
Hypercore by providing Hypercore with management services and
computer equipment;
l)
During the 1996 taxation year the Appellant earned $60,015.00
from Hypercore by providing Hypercore with management services
and computer equipment;
m) During the 1997
taxation year the Appellant earned $54.624.00 from Hypercore by
providing Hypercore with management services and computer
equipment;
n) Joseph
Donlevy prepared, or had a member of his staff prepare, invoices
from the Appellant to Hypercore for the amounts specified in
assumptions (k), (l) and (m);
o) The
invoices referred to in subparagraph (n) were based on the amount
of time Joseph spent managing Hypercore's business affairs
and the amount of equipment rented;
p) The
invoices referred to in subparagraph (n) were used by Hypercore
to support its claims for SRED and CANARIE grants;
q) The amounts
Hypercore received from SRED and CANARIE grants were reinvested
in Hypercore, instead of being paid to the Appellant;
r) The
Appellant agreed that the amounts Hypercore received from SRED
and CANARIE grants should be reinvested in Hypercore;
s) The
in-house staff, managed by Joseph Donlevy, prepared the
Appellant's books and records;
t) The
Appellant failed to record the above noted income or the
receivables from Hypercore in its corporate books and records for
1995, 1996 and 1997; nor did the Appellant include the amounts in
an allowance for doubtful accounts or bad debts in its books and
records;
u) The
Appellant failed to include the above noted amounts in income in
filing its returns for the 1995, 1996 and 1997 taxation
years;
v) All of the
Appellant's revenue is generated by managing other business
operations.
w) The
Appellant's accountant also prepared Hypercore's income
tax returns;
x) The
Appellant's accountant stated that the amounts payable by
Hypercore, which included the amounts paid to the Appellant, were
converted to capital in order to support Hypercore's SRED
claim;
y) The
Appellant's accountant admitted that the conversion of
payables to share capital is in fact payment of the expenditures
and a subsequent reinvestment in Hypercore;
z) Joseph
Donlevy has at least a basic understanding of tax matters;
aa) Joseph Donlevy has
vast business experience with various corporations, government
departments and personal financial activities;
bb) Joseph Donlevy signed
a memo dated January 26, 1996, indicating that the Appellant
agreed to loan the amount payable with respect to the equipment
rentals to Hypercore;
cc) Joseph Donlevy signed
an agreement on behalf of the Appellant converting the amount
payable by Hypercore to the Appellant into contributed
capital;
dd) The amounts payable to
the Appellant by Hypercore were not bad debts;
ee) The Appellant did not
attempt to collect the amounts from Hypercore;
ff) Hypercore
continued to carry on its research;
gg) The potential of
Hypercore's research continued to progress;
hh) Hypercore remained a
going concern, funds continued to be injected into the
company;
ii)
Hypercore's financial statements did not account for the
value of the technical knowledge gained by the company;
jj) Joseph
Donlevy, the principal of the Appellant, was well aware of
Hypercore's circumstances and potential;
kk) The Appellant
continued to provide Hypercore with Mr. Donlevy's services
and with computer equipment;
ll) Develcon
was a public company;
mm) In 1995 Develcon bought shares in
Hypercore and acquired an option to purchase additional
shares;
nn) Develcon exercised the
option;
oo) Develcon paid
$1,483,937.40 for the shares;
pp) The Appellant's
accountant, Tom Zurowski, concurred with the amounts being
included in income;
qq) The Appellant's
method of accounting for the amounts receivable from Hypercore
did not adhere to the CICA Accounting Recommendations and
generally accepted reporting methods; and
rr) The amount of
$200,195.00 owing to the Appellant was shown as a shareholder
loan in the Unanimous Shareholders Agreement.
ss) The Appellant
reported taxable income of $43,635.00 in the 1995 taxation year.
The Appellant's taxable income for the 1995 taxation year was
at least $56,903.00. The income of the Appellant was understated
by $13,268.00 in the 1995 taxation year;
tt) The
Appellant reported taxable income of $28,921.00 in the 1996
taxation year. The Appellant's income for the 1996 taxation
year was at least $88,936.00. The income of the Appellant was
understated by $60,015.00 in the 1996 taxation year.
uu) The Appellant reported
taxable income of $167,840.00 in the 1997 taxation year. The
Appellant's taxable income for the 1997 taxation year was at
least $222,464.00. The income of the Appellant was understated by
$54,624.00 in the 1997 taxation year;
vv) By failing to include
the above noted amounts in income the Appellant made
misrepresentations in filing its returns for the above noted
taxation years that is attributable to neglect, carelessness or
wilful default;
ww) The Appellant knowingly, or under
circumstances amounting to gross negligence in carrying out a
duty or obligation imposed under the Act, made or
participated in, assented to or acquiesced in the making of false
statements or omissions in the income tax returns filed for the
1995, 1996 and 1997 taxation years, as a result of which the tax
that would have been payable assessed on the information provided
in the Appellant's income tax returns filed for those years
was less than the tax payable by the amounts of $1,734.86,
$17,463.16 and $15,906.51, respectively;
22. As a consequence of
the said understatement of income, the Minister assessed the
Appellant the following penalties under subsection 163(2) of the
Act for the 1995, 1996 and 1997 taxation years:
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Taxation Year
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Penalties
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1995
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$867.43
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1996
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$8,731.58
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1997
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$7,953.25
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B. ISSUES
TO BE DECIDED
23. The issues are:
(a) Whether the
Appellant's income for the 1995, 1996 and 1997 taxation years
was understated;
(b) Whether the
Minister may make a reassessment for tax, penalties and interest
in respect of the Appellant's 1995 taxation year pursuant to
subparagraph 152(4)(a)(i); and
(c) Whether the
Minister properly assessed penalties pursuant to subsection
163(2) of the Act in the 1995, 1996 and 1997 taxation
years.
[4] Assumptions 21 a), b), c), d), e),
f), g), i), j), k), l), m), n), o), p), s), t) and u), except for
two invoices in 1995, w), z), ee), ii), but see paragraph [8] jj)
below, jj), kk), ll), mm), nn), oo) and pp) were not refuted.
[5] With respect to the remaining
assumptions in paragraph 21:
h) Is true except
that Mr. Donlevy did not apply for the SRED grants. Those grants
were applied for after Mr. Donlevy and Mr. Konkin had sold all of
their shares to Develcon which then owned 100 percent of the
shares in Hypercore.
q) The SRED grants were
obtained after ownership of Hypercore was transferred to
Develcon; how they were used by Develcon or Hypercore at that
time is not known, but Hypercore was no longer in business.
r) The Appellants
were not shareholders of Hypercore and their agreement or
disagreement in respect to the CANARIE grants was irrelevant,
since they were Hypercore's property. The SRED grants were
applied for and received by Hypercore after the years in
question.
v) Is wrong.
Chartwell also rented equipment for fees.
x) and y) Are correct but
the Appellants' accountant advised and recorded this on
behalf of Hypercore in its capacity as Hypercore's
accountant. The statement was made on the basis of the
accountant's knowledge of the facts.
aa) Joseph Donlevy's
business experience is extensive, but not "vast", and
at the time included having been involved in the operations of
two businesses which failed. Thus, the quality of that experience
is questionable.
bb) Is correct. But the evidence is
that the amounts invoiced were never paid to the Appellants to be
loaned back in cash or even used as a book entry. Hypercore's
cash flow problems were so great that its revenue was used to pay
engineers' wages and to purchase necessary equipment, and not
to pay the Appellants.
cc) Is wrong. Messrs. Donlevy
and Konkin each signed the agreement on his own behalf as a
shareholder but not on behalf of the Appellants.
dd) The amounts payable to the
Appellants were never declared or elected by the Appellant to be
doubtful or bad debts. However, the evidence before the Court is
that Hypercore was always so short of cash of its own that it was
at all times insolvent. Without loans from shareholders, new
shareholders' capital and delaying payments to non-employees
it would have always been in receivership or bankrupt. For this
reason the amounts payable to the Appellants by Hypercore were at
all times, in fact, bad debts.
ff) and gg) Hypercore carried on its
research except from October 31 to December 31, 1995 when
Hypercore lacked funds and from about June, 1997 on after which
it never had sufficient funds and its engineers were doing
demonstrations to possible lenders or investors. During these
demonstrations it became clear to Mr. Konkin (and the Court
accepts it as true) that the projected switch being developed by
Hypercore had been passed by, by the industry which had adopted
another system of technology for switches. In fact, due to
insufficient funds Hypercore had to make do at all times with
inadequate tools and with using programmable technology (rather
than manufacturing its own integrated circuits), as a result of
which its only demonstrable switch operated at one-half the
projected speed and with unsatisfactory wiring and computer
connections in 1997. An outside review by "Technica"
which was required by Develcon in 1997, established that the
proposed switch needed two more years of work, a further
investment of 7 million dollars (U.S.) and the services of an
experienced product development team.
hh) The result is that from its
beginning in 1995 on, Hypercore was a limping concern operating
from day to day with a shortage of cash, inadequate equipment and
with limited staff. It could not develop its hypertube switch
idea for telecommunications using the latest technology. As a
result, from the moment that Hypercore was unable to manufacture
its own integrated circuits for the hypertube switch, it was
doomed to fail in the fast moving, high-tech, electronics
business. That conclusion is not merely hindsight. The evidence
of Mr. Konkin is that Hypercore's engineering staff knew then
that they lacked the funds to manufacture their own integrated
circuit. As a result, the Technica Study and Hypercore's own
1997 demonstrations further confirmed that what it had developed
with the equipment it had was too slow compared to the standard
Hypercore itself had set for the task of the switch.
hh) Thus, the injection
of $200,000 in new shareholder's funds on September 25, 1997,
(Exhibit A-3) was merely a stop gap. The cash flow projection by
Hypercore in November and December 1995 and ultimately adopted in
the CANARIE contract of January 23, 1996 (Exhibit A-1, Tabs 11,
12 and 13) established a shortage of $443,498 for which there was
no source of funds. Moreover it was based on not meeting
obligations to pay and paying invoices which were absolutely
necessary 90 days late. All of its subsequent funds, except the
$200,000, came from CANARIE grants.
qq) Is wrong. Exhibit A-1, 27,
paragraph 16, of the CICA Accounting Recommendations states:
...
.16 Recognition of revenue
requires that the revenue is measurable and that ultimate
collection is reasonably assured. When there is reasonable
assurance of the ultimate collection, revenue is recognized even
though cash receipts are deferred. When there is uncertainty as
to ultimate collection, it may be appropriate to recognize
revenue only as cash is received.
...
It was on the basis of this that KPMG, LLP, as Chartwell's
accountant, advised the Appellant not to show the invoices in its
financial records and not to report them for income tax purposes.
Mr. Donlevy advised Mr. Konkin of Centus of this advice and
Centus adopted the same course. For unremembered reasons, and
perhaps inadvertence, Chartwell failed to carry this advice out
correctly respecting its 1995 financial statement, when it did
record as a receivable for revenue purposes two management fee
invoices, but did not report rental invoices from Chartwell to
Hypercore. Both Mr. Donlevy and Mr. Konkin testified that
Hypercore could not pay the invoices to their and the
Appellants' knowledge, that they did not report them because
they had faith in the knowledge and quality of KPMG's advice
and that they did not fail to report the items in order to avoid
paying taxes. Indeed, as Mr. Zurowski pointed out, the amounts
could have been recorded and then written off, but the CICA
handbook advised the course adopted, whereupon he advised it.
rr) The amounts in
question were not shown as shareholder loans in the unanimous
shareholders' agreement. They were simply recorded there, and
the Appellants never executed that document.
ss), tt), uu), vv) and ww)Will be dealt with in what
follows.
[6] Paragraphs 17 to 21 inclusive of
the Reply to the Notice of Appeal of Centus Inc. outline the
facts in issue in that matter. They read:
17. In computing income
for the 1996 taxation year, the Appellant failed to include
income earned totaling $26,000.00. In reassessing the Appellant
for the 1996 taxation year, the Minister added $26,000.00 to the
Appellant's income. The Minister also assessed penalties in
the 1996 taxation year pursuant to subsection 163(2) of the
Act.
18. In computing its
income for the 1997 taxation year, the Appellant failed to
include income earned totaling $26,000.00. In reassessing the
Appellant for the 1997 taxation year, the Minister added
$26,000.00 to the Appellant's income. The Minister also
assessed penalties in the 1997 taxation year pursuant to
subsection 163(2) of the Act.
19. The Minister issued
Notices of Reassessment for the Appellant's 1996 and 1997
taxation years on July 31, 2000.
20. In so reassessing the
Appellant for the 1996 and 1997 taxation years, the Minister
relied on, inter alia, the following assumptions of
fact:
a) The Appellant
is a corporation;
b) The
Appellant carried on business in the Province of
Saskatchewan;
c) The
Appellant's head office was in the City of Saskatoon,
Saskatchewan;
d) The
Appellant was engaged in the business of computer system
management and/or computer system consulting;
e) At all
relevant times, Douglas Konkin owned 76% and Mary Donlevy-Konkin
owned 24% of the issued and outstanding shares in the capital of
the Appellant;
f) At
all relevant times, Douglas Konkin was a director and held the
office of president of the Appellant;
g) At all
relevant times, Douglas Konkin was a shareholder of
Hypercore;
h) At all
relevant times, Douglas Konkin was a director and held the office
of secretary of Hypercore;
i) At
all relevant times, Douglas Konkin was a computer manager of
Hypercore;
j)
Hypercore carried on business in the Province of Saskatchewan
consisting of scientific research and development;
k) At all
relevant times, Martin Joseph Donlevy, also known as Joe or
Joseph Donlevy was responsible for the financial management of
Hypercore, which included finding additional capital, applying
for grants from CANARIE and applying for Scientific Research and
Experimental Development ("SRED") claims;
l)
During the 1996 and 1997 taxation years, the Appellant provided
computer system management and/or computer system consulting to
Hypercore;
m) During the 1996
and 1997 taxation years, the Appellant provided equipment and
other goods to Hypercore;
n) During the
1996 taxation year, the Appellant earned at least $26,000.00 from
Hypercore by providing Hypercore with computer system management
and/or computer system consulting;
o) During the
1997 taxation year, the Appellant earned at least $26,000.00 from
Hypercore by providing Hypercore with computer system management
and/or computer system consulting;
p) Invoices
from the Appellant to Hypercore for the amounts specified in
assumptions n) and o) were based on the amount of time Douglas
Konkin spent providing computer system management and/or computer
system consulting;
q) Douglas
Konkin agreed that the Appellant would invoice Hypercore and then
loan the funds back to Hypercore;
r) The
Appellant was aware that Hypercore set up the amounts owed to the
Appellant as an account payable in its books and records;
s) The
invoices referred to in subparagraph p) were used by Hypercore to
support its claims for CANARIE and SRED grants;
t) The
amounts Hypercore received from CANARIE and SRED grants were
reinvested in Hypercore instead of being paid to the
Appellant;
u) The
Appellant agreed that the amounts Hypercore received from CANARIE
and SRED grants should be reinvested in Hypercore;
v) Douglas
Konkin prepared the Appellant's books and records;
w) The Appellant
failed to record the above noted income or the receivables from
Hypercore in its corporate books and records for 1996 and 1997;
nor did the Appellant include the amounts in an allowance for
doubtful accounts or bad debts in its books and records;
x) The
Appellant failed to include the above noted amounts in income in
filing its returns for the 1996 and 1997 taxation years;
y) All of the
Appellant's revenue is generated by managing other business
operations;
z) KPMG
Chartered Accountants prepared Hypercore's income tax
returns;
aa) KPMG Chartered
Accountants stated that the amounts payable by Hypercore, which
included the amounts paid to the Appellant, were converted to
capital in order to support Hypercore's SRED claim;
bb) Douglas Konkin has at
least a basic understanding of tax matters;
cc) Douglas Konkin has
business experience with various corporations, government
departments and personal financial activities;
dd) Douglas Konkin signed
an agreement on behalf of the Appellant converting the amount
payable by Hypercore to the Appellant into contributed
capital;
ee) The amounts payable to
the Appellant by Hypercore were not bad debts;
ff) The
Appellant did not attempt to collect the amounts from
Hypercore;
gg) Hypercore continued to
carry on its research;
hh) The potential of
Hypercore's research continued to progress;
ii) Hypercore
remained a going concern, and funds continued to be injected into
the company;
jj)
Hypercore's financial statements did not account for the
value of the technical knowledge gained by the company;
kk) Douglas Konkin was
well aware of Hypercore's circumstances and potential;
ll) The
Appellant continued to provide Hypercore with Douglas
Konkin's computer system management and/or computer system
consulting;
mm) Develcon was a public company;
nn) In 1995, Develcon
bought shares in Hypercore and acquired an option to purchase
additional shares;
oo) In 1998, Develcon
exercised the option;
pp) Develcon paid
$1,438.937.40 for the shares;
qq) The Appellant's
method of accounting for the amounts receivable from Hypercore
did not adhere to the CICA Accounting Recommendations and
generally accepted accounting principles;
rr) The amount of
$59,120.00 owing to the Appellant was shown as a shareholder loan
in the Unanimous Shareholders Resolution;
ss) The Appellant
reported a net loss of $11,550.00 in the 1996 taxation year;
tt) The
Appellant's taxable income for the 1996 taxation year was at
least $14,450.00;
uu) The income of the
Appellant was understated by $26,000.00 in the 1996 taxation
year;
vv) The Appellant reported
a net loss of $4,975.00 in the 1997 taxation year;
ww) The Appellant's taxable income
for the 1997 taxation year was at least $21,025.00;
xx) The income of the
Appellant was understated by $26,000.00 in the 1997 taxation
year;
yy) By failing to include
the above noted amounts in income, the Appellant made
misrepresentations in filing its returns for the above noted
taxation years that is attributable to neglect, carelessness or
wilful default;
zz) The Appellant
knowingly, or under circumstances amounting to gross negligence
in carrying out a duty or obligation imposed under the
Act, made or participated in, assented to or acquiesced in
the making of false statements or omissions in the income tax
returns filed for the 1996 and 1997 taxation years, as a result
of which the tax that would have been payable assessed on the
information provided in the Appellant's income tax returns
filed for those years was less than the tax payable by the
amounts of $3,411.00 and $3,411.00 respectively.
21. As a consequence of
the said understatement of income, the Minister assessed the
Appellant the following penalties under subsection 163(2) of the
Act for the 1996 and 1997 taxation years:
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Taxation Year
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Penalties
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1996
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$1,705.50
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1997
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$1,705.50
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[7] Assumptions 20 a) to j) inclusive,
l) to s) inclusive, v) to z) inclusive, cc), ff), kk) to pp)
inclusive, and ss) and vv) were not refuted.
[8] With respect to the remaining
assumptions, the Court finds:
k) See [5] h)
above.
t) See [5] q)
above.
u) See [5] r)
above.
aa) See [5] x) and y)
above.
bb) This is not true. Mr. Konkin
relied on Mr. Donlevy's advice in tax matters;
dd) See [5] cc) above.
ee) See [5] dd) above.
gg), hh) and ii)
See [5] ff), gg) and hh) above.
jj) Is correct
insofar as it is expressed. However, based on the comments on
assumptions gg), hh) and ii) above and on the comments referred
to therein, the technical knowledge gained by Hypercore was out
of date due to the technology it was forced to use by its
financial circumstances.
qq) See [5] qq) above. The Appellant relied
on Mr. Donlevy's advice, which was based on knowledge he
obtained from KPMG.
rr) See [5] rr)
above.
tt), uu), ww), xx), yy) and zz) Will
be dealt with in what follows.
[9] These assessments came about
because the Appellants invoiced Hypercore and except as stated
respecting Chartwell's two 1995 management fee invoices, did
not record them in any way in their books and records. But
Hypercore recorded and then claimed the invoices when applying
for SRED grants. They were denied because Hypercore never paid
the invoices. The SRED auditor advised the income tax section of
the problem which had been created and these assessments and
appeals followed.
[10] In particular, CRA is of the view that
the Appellants simply cancelled the Hypercore debts, Messrs.
Donlevy and Konkin sold their shares in Hypercore and, in essence
were paid in that manner. Therefore CRA's argument is that
Hypercore was under the management of Messrs. Donlevy and Konkin
and could have paid the invoices somehow - essentially by robbing
creditor Peter to pay creditor Paul. However the only money
Hypercore ever got was either from CANARIE grants or from
shareholder loans or capital. In other words, Hypercore never had
the money to pay anything but wages, withholdings and essential
outside supplies. It had to buy the supplies on the cheap due to
lack of funds and this contributed to its failure. It was a
vicious downward spiral, which was only sustained by the hope of
finding new investors which were never forth-coming. Even at the
time this was apparent to an objective observer, which was why it
failed to obtain any more money from CANARIE or anyone else
except the two who invested $200,000 but who were oblivious to
the January 1996 forecast of a need for over $400,000 in
additional money based upon late payments and withholdings. That
forecast was incredibly optimistic. But that forecast and these
facts are why the Court finds that the Chartwell and Centus
invoices constituted bad debts even at the times that they were
issued during the years in question.
[11] After December 15, 1995, the
shareholdings in Hypercore were:
Joe Donlevy
24
Douglas Konkin 21
Carl McCrosky
15
Develcon
40
Total
100
These were split 100 for 1 on September 11, 1997. With the
investment of $100,000 each on September 25, 1997 by Chelsea
Management Inc. and VHL Management Inc. (Bearer shares), the
shareholdings in Hypercore became, as quoted from Exhibit
A-3:
|
Joe Donlevy
|
2,400
|
17%
|
|
Douglas Konkin
|
2,100
|
15%
|
|
Carl McCrosky
|
1,500
|
10%
|
|
Develcon
|
4,000
|
28%
|
|
Chelsea Management Inc.
|
2,209
|
15%
|
|
Bearer
|
2,209
|
15%
|
(See exhibit A-3)
Thus, after December 15, 1995 Messrs. Donlevy and Konkin were
always minority shareholders of Hypercore.
[12] Mr. Donlevy admitted that before the
sale of all of Hypercore's shares to Develcon, Hypercore
received an offer to purchase its technology. But the
shareholders would not accept it; they wanted to sell their
shares. Messrs. Donlevy and Konkin were minority
shareholders, so they had no control over this decision, which is
a common decision for any shareholders of a small corporation if
a share sale can be arranged. The Develcon offer for all of the
non-Develcon shares in Hypercore of $1,483,937.40 followed on the
basis that Hypercore was clean of any debt. Therefore all debt,
including Chartwell's and Centus' was forgiven and the
shares were sold by all the shareholders to Develcon. Mr. Donlevy
believes that Develcon later sold Hypercore's technology to
P.M.C. Sierra Inc. ("Sierra") for $2,000,000. Mr.
Konkin went to work for Sierra with engineers. Sierra terminated
its Hypercore technology programme a year later when it also
failed to make it marketable.
[13] Part of the Respondent's theory is
that Messrs. Donlevy and Konkin chose to cancel the
Appellant's debts and sell capital. However that theory fails
once it is understood that by the time that the offers came in
Messrs. Donlevy and Konkin were in a distinct minority in a
failed enterprise, namely Hypercore. In those circumstances, you
do what you have to do. That is what Chartwell, Centus, Donlevy
and Konkin did. In particular, the Court finds that
Chartwell's and Centus' debts from Hypercore were bad
debts anyway - cancelling them merely formalized a fact.
[14] Paragraph 12(1)(b) of the
Income Tax Act required that the invoices be reported as
receivables for income tax purposes. It reads:
12. (1) There shall be included in computing the income
of a taxpayer for a taxation year as income from a business or
property such of the following amounts as are applicable
...
(b) any amount receivable by the taxpayer in respect of
property sold or services rendered in the course of a business in
the year, notwithstanding that the amount or any part thereof is
not due until a subsequent year, unless the method adopted by the
taxpayer for computing income from the business and accepted for
the purpose of this Part does not require the taxpayer to include
any amount receivable in computing the taxpayer's income for
a taxation year unless it has been received in the year, and for
the purposes of this paragraph, an amount shall be deemed to have
become receivable in respect of services rendered in the course
of a business on the day that is the earlier of
(i) the day on which the account in respect of the services
was rendered, and
(ii) the day on which the account in respect of those services
would have been rendered had there been no undue delay in
rendering the account in respect of the services;
...
[15] The Appellants did not do this, based
upon the KPMG, LLP advice which, in turn, was based on the CICA
handbook as quoted. But for tax purposes the Income Tax
Act overrides the CICA handbook. However, the Court finds
that the actions of the Appellants in relying on the advice of a
major reputable international chartered accounting firm such as
KPMG, LLP and on the CICA handbook, does not constitute
negligence within the meaning of subsection 163(2) of the
Income Tax Act and therefore the appeals are allowed in
respect to the penalty portions of the assessments.
[16] However, Chartwell's willful
default in reporting receivables in 1995 in direction violation
of paragraph 12(1)(b) of the Income Tax Act does
entitle the Respondent to reassess its 1995 taxation year.
[17] The Respondent did not refer to
paragraph 12(1)(b) in any part of the audit processes or in the
pleadings in these appeals. It referred to Section 9 of the
Income Tax Act on the alleged premise that Section 9
included paragraph 12(1)(b).
[18] In these circumstances, the appeals are
allowed and these matters are referred to the Minister of
National Revenue for reconsideration and reassessment on the
basis that the amounts in question for each Appellant for the
years in dispute constituted bad debts in those years.
[19] No costs are awarded to any party.
Signed at Ottawa, Canada, this 8th day of November 2004.
Beaubier, J.
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