Date: 20010821
Docket: 98-1745-IT-G
BETWEEN:
GLENN McCARTHY,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
_______________________________________________________
Counsel for the Appellant: D. Andrew Rouse
Counsel for the Respondent: Marcel Prevost
_______________________________________________________
Reasons for Judgment
(Delivered orally from the Bench at Fredericton, New
Brunswick, on July 13, 2001)
Bowie J.
[1]
Mr. McCarthy appeals from assessments for income tax for the
1992, 1993 and 1994 taxation years. The assessments were done by
the net worth method, and they increased his income in 1992 by
$100,027, in 1993 by $33,818 and in 1994 by $40,086.
[2]
Net worth assessments are made by the Minister of National
Revenue (the Minister) either because the taxpayer has not
maintained books and records that will permit an assessment of
his income to be made by ordinary methods of accounting, or where
the books and records kept by the taxpayer are thought not to be
reliable. A net worth assessment has been called a crude
assessing tool, and so it is. However, there are situations in
which the Minister has no reasonable alternative but to resort to
it. That this is one such occasion is not disputed by Mr. Rouse,
counsel for the taxpayer.
[3]
In simple terms, the net worth approach to estimating income
consists of establishing a personal balance sheet for the
taxpayer. The Minister, so far as he can, computes the assets and
the liabilities of the taxpayer at the beginning of the year
being assessed and at the end of it. He also estimates the living
expenses of the taxpayer for the year. Those living expenses,
plus any increase or minus any decrease in net worth during the
year, is then assumed to be the taxpayer's income for the
year, subject to any other explanation that the taxpayer may have
of the change in net worth, such as the receipt of an
inheritance, or a run of good luck at the casino. As with all
assessments of tax, once it has been made it is for the taxpayer
to show by his evidence that it is wrong. Net worth assessments
usually include many variables, any or all of which may be the
subject of attack by the taxpayer. In the present case, Mr. Rouse
has not taken the approach, often favoured, of attacking many of
the elements of the assessment with a view to raising doubt where
he may. Instead, he has chosen to attack four discrete elements
of the net worth calculations. Before I turn to those, however, I
should say a few words about the Appellant.
[4]
Glenn McCarthy grew up in the Miramichi region of New Brunswick,
in or around Blackville. At some point he moved to Ontario to
work and live. There he seems to have prospered, at least in
part, through the considerable inflation of real estate values
which took place in the 1970s and 1980s. When he retired and
returned to the Blackville area, it was with a considerable
amount of liquid cash to invest. Most unfortunately, between the
years under appeal and the present time, he suffered a very
serious injury in a motor vehicle accident. He was unconscious
for some six months, and when he recovered it was with some
residual brain damage which has caused significant loss of
memory. Consequently, his recollection of events which took place
in and around the years under appeal is incomplete. He frequently
said in his evidence that he does not recall information that
under other circumstances he would have been expected to
remember. I do not have the impression that he did so to be
evasive; for the most part, I believe that he tried to answer the
questions he was asked fully and truthfully. Unfortunately, he
was not always able to do so. Nevertheless, the burden of proof
is his to discharge as best he can.
[5] I
return now to deal with the objections which the Appellant has
raised to the assessments under appeal. When the Appellant
returned to Blackville, shortly before the years under appeal, he
started a business called the Blackville Diner and Take-Out
Incorporated. I shall call the corporation "the Diner".
It operated a diner, as the name suggests, in the Village of
Blackville. Mr. McCarthy was the only shareholder, officer
and director of the corporation. Blackville is a small community,
and the Diner was a small operation, run by Mr. McCarthy and
one or two other people at any given time. Its premises at first
were old and inadequate, and Mr. McCarthy spent a good deal of
money in the period between July 1991 and July 1992 to improve
them; somewhere between $32,000 and $35,000. He also built a
garage in the summer of 1994. The Diner was not a profitable
venture. According to the financial statements in evidence, it
reported the following losses: in 1991, $16,775; in 1992,
$29,841; in 1993, $12,729; in 1994, $15,714.
[6]
Once a net worth is established for the beginning of a period
being assessed, any increase in the assets of the taxpayer during
that period has the effect of increasing the estimate of the
taxpayer's income for the period, unless it is accompanied
by an offsetting liability. The bookkeeper who prepared the
annual financial statements for the Diner operated on the
assumption that the loss for each year must have been supported
by equal contributions of cash to the business in the form of
loans from Mr. McCarthy. Consequently, each year the
company's balance sheet shows a loan balance owing to Mr.
McCarthy which is greater than the previous year end loan balance
by the amount of the loss recorded for the year just ended. This,
of course, is a crude method of accounting, but with the records
available to him it is no doubt the best that he could do, and
neither party disputed the use of this methodology in arriving at
the balance of Mr. McCarthy's shareholder loan account at
the end of each of the relevant years. However, the Appellant
does dispute the quantum of the losses said to have been suffered
by the Diner in each of the years under appeal. He says that they
are too high. If he is correct, then the amount added to his loan
account is also too great, and the effect is to overestimate his
net worth at the end of the year to that same extent.
[7]
The Respondent, while not disputing that to overstate the loss
would have that effect, says that the losses are in fact not
overstated, and that the assessor was entitled to rely as he did
on the financial statements of the Diner for each of the relevant
years. The major issue in dispute then, is whether or not those
losses are overstated, and if so by how much. I shall return to
that issue shortly. First, I will deal with the other three
issues that Mr. Rouse has raised.
The truck
[8]
The first of these is the truck. The assessor learned that Mr.
McCarthy had acquired a new 1992 model truck. He included it in
Mr. McCarthy's assets for the first time in the year 1992.
In fact, Mr. McCarthy acquired the truck in late December 1991,
and so it should have been included in his December 31, 1991 net
worth. Mr. McCarthy's evidence as to this is corroborated
by insurance records. Mr. Prevost, for the Crown, quite properly
conceded this issue at the trial, after the evidence established
the fact that the truck was acquired in 1991 and not 1992.
Sixteen thousand dollars is the value of the truck, and this
amount is to be deleted from the estimate of income for the 1992
year.
The garage
[9]
The assessor mistakenly believed that the garage was built in
1993. He estimated its value at $15,000, and he included that
amount in Mr. McCarthy's net worth at December 31, 1993. He
said in his evidence that he expected Mr. McCarthy to
dispute the $15,000 value, and that he would then have attempted
to negotiate an agreed-upon value. In fact, the garage was built
in 1994, as the numerous receipts for materials prove. Mr. Derek
Williston, an experienced carpenter, gave the opinion in evidence
that the materials at that time would have cost about $4,500. He
did not pretend to fix the figure precisely, because prices do
vary, and estimates are only that. For example, the range of
prices for garage doors is considerable, depending on the
quality. The one actually bought and installed cost somewhat more
than Mr. Williston had allowed. I think that $5,000 is a likely
amount for the materials that went into the construction of the
garage. The labour was contributed by a Mr. McCormack. Mr.
McCormack was not paid for his labour, he said, because he had an
arrangement with Mr. McCarthy that he would be able to use
the garage to run a small engine repair business after it was
built. In fact, that business never came into existence, and Mr.
McCormack did not get any benefit from his labour. Despite a
vigorous cross-examination, I accept his evidence that he was not
paid. The garage should not have been included in Mr.
McCarthy's assets in 1993 at a cost of $15,000. It should
have been added in 1994 at a cost of $5,000. The $15,000 should
be deleted from the 1993 taxation year. I shall return to the
question of whether the $5,000 should be added to 1994.
Renovations
[10] The next
item is the Diner renovations. When the renovations were carried
out on the Diner premises, the bookkeeper, for reasons which the
evidence does not reveal, accounted for them by adding $35,000,
or more precisely $34,999.91, to the value of buildings shown on
the balance sheet, and at the same time he added an equal amount
to Mr. McCarthy's shareholder loan account, no doubt on the
theory that Mr. McCarthy personally must have been the source of
the funds to pay for the work and materials. In fact, much of the
spending was done in 1991, not 1992, and the increase to Mr.
McCarthy's loan account should have reflected this.
Vouchers totalling some $32,264 were produced at trial; of these,
$24,401 were for amounts spent in 1991 and $7,863 were for
amounts spent in 1992.
[11] The
Appellant's record-keeping is such that I can have no
confidence that he was able to produce all the invoices for all
the work and materials. The bookkeeper's number of
$34,999.91 is likely more accurate. However, I agree with Mr.
Rouse that the amount spent in 1991 should have been added to the
loan account in 1991, and the amount spent in 1992 should have
been added to it in that year. Mr. McCarthy's entitlement
to be repaid logically dates from the time at which he made the
outlay. His December 31, 1991 loan account balance should
therefore reflect the $24,401 which he has shown was expended in
1991. This has the effect of reducing the estimate of his income
for 1992 by that amount.
Overstated Losses
[12] I come
now to the overstated losses of the Diner, which is the most
unusual aspect of the appeals. The Appellant's contention
is that the losses of the Diner were overstated in each of the
1992, 1993 and 1994 years, with the result that the increases to
his shareholder loan balance were also overstated, causing the
estimate of his net worth and, therefore, the estimate of his
income for each of the years, to be overstated as well. This
contention is based upon evidence that Mr. McCarthy, as the
manager of the Diner, engaged in a practice of creating false
entries in the payroll records of the Diner. These false records
show wages to have been paid to a number of persons which were
never paid at all. They recorded expenses never incurred, and so
resulted in an inflation of the loss for each year. If the only
evidence of this practice came from the Appellant himself, I
would be inclined to disbelieve it. That was not the case,
however. Four individuals gave evidence to the effect that they
had been on the Diner payroll for periods in excess of the time
that they actually worked there, or, in two of the cases, that
they never worked there at all.
[13] Jackie
Curtis said that she worked at the Diner for one week in 1992,
for which she received no pay whatsoever. She did, however,
receive a Record of Employment showing that she had worked there
for several weeks, and she received a T4 slip for that year
showing earnings of $3,009. She used the Record of Employment to
apply for and receive unemployment insurance benefits. The
payroll ledger shows her as having been paid a gross amount of
$3,009.
[14] Roberta
Duffy also received a Record of Employment showing that she had
worked at the Diner in 1992. However, her evidence was that she
did not work there at all. She received a T4 slip showing gross
earnings of $4,150 for the year, and that amount was recorded in
the payroll ledger. She testified that her father and Mr.
McCarthy were friends, and that her father had arranged with
Mr. McCarthy that this false Record of Employment would be
given to her for her benefit. She believed that her father had
paid Mr. McCarthy some money as part of this arrangement, but she
could not say how much.
[15] Velma
Campbell gave similar evidence. In 1994, she worked for four,
five or six weeks at the Diner -- she was uncertain which. She
said that she was not paid at all, because Mr. McCarthy told her
that he was not making enough money to be able to pay her. He
could, however, give her a false Record of Employment if she
would work without pay, and that is what in fact happened. She
was given a T4 slip showing earnings of $2,013 for the year,
which she never received. She, too, used the Record of Employment
to apply for and receive unemployment insurance benefits. She
said that she had paid Mr. McCarthy, whom she had known for
many years, something in return for doing this, but she also
could not be sure how much.
[16] Jo-Anne
Burns said that she worked at the Diner in 1992, 1993 and 1994,
but received no pay for doing so. She did, however, receive a
false Record of Employment, and she too received unemployment
insurance benefits on the strength of it. Her T4 slips for the
three years showed gross earnings of $7,516, $7,754 and $10,113
for these three years, and these same amounts appear as her gross
pay in the payroll records. Jo-Anne Burns also arranged a similar
transaction with Mr. McCarthy for her mother, Doreen Burns.
Doreen Burns did not work at the Diner at all, but in 1994 she
too was given a false Record of Employment which she used to
obtain benefits, and she was given a T4 slip showing earnings of
$4,589. That amount was charged as her gross pay in the payroll
ledger.
[17] Mr.
Prevost cross-examined all of these witnesses thoroughly, but did
not shake their evidence. They all knew that they were committing
an offence when they claimed unemployment insurance benefits on
the basis of false Records of Employment. They knew that it was
an offence, as well, to file false income tax returns. Mr.
Prevost argued that their evidence was not credible, and he asked
me to dispose of this aspect of the case on that basis.
[18] I
observed all of these four witnesses carefully. I think it is
most unlikely that any of them would commit perjury, and admit
under oath to committing serious offences, if they had not, in
fact, done so. It is not logical that they would give that
evidence simply to assist Mr. McCarthy in his income tax appeals.
All of these witnesses appeared to me to be telling the truth to
the best of their recollection. I accept their evidence that they
did not receive the pay that was recorded as having been paid to
them. I believe that the attitude of Mr. McCarthy and of
these four witnesses was, as Ms. Burns put it in her evidence,
"... that's what friends are for...". Perhaps
Mr. McCarthy felt that he was enhancing his standing in the
community by conferring benefits on people to which they were not
entitled. In any event, I accept that the payroll entries for
these five people were falsified, and the effect was to overstate
the losses of the Diner for the years in question. I reach that
conclusion on the basis of my observation of the demeanour of
each of Ms. Curtis, Ms. Duffy, Ms. Campbell and Ms. Burns, and
also because their evidence is a more probable scenario than the
alternative, which is that they were committing perjury to assist
Mr. McCarthy.
[19] I do not,
however, accept Mr. McCarthy's evidence that he too did not
receive certain pay recorded in the Diner's payroll ledger
as having been paid to him. I have referred already to his memory
loss. It is illogical that he would have created a false payroll
record for himself. He would not have been in a position to
benefit, personally, from doing that. He also had considerable to
gain by giving this evidence, as it would be to his benefit in
this appeal.
[20] There was
some evidence that amounts were paid to Mr. McCarthy by the
employees who gave evidence, or in the case of Ms. Duffy, by her
father, and also by Doreen Burns. However, this evidence from
each of the witnesses was so vague as to be worthless. I conclude
on the balance of probability that of the amounts charged as a
payroll expense in the case of each of the five employees in
question, it was only the net pay shown in column 10 of the
payroll ledger sheets that was not, in fact, paid. I believe the
evidence to the effect that the various amounts for the Canada
Pension Plan contributions, unemployment insurance premiums and
withholding of income tax were, in fact, remitted. Had they not
been, the whole scheme would have been quickly detected.
[21] It may
seem counter-intuitive that the Appellant can achieve a degree of
success in this appeal by leading evidence of his own fraud. No
authority dealing with that issue has been cited to me, and I am
not aware of any. This is not a case where the issue is whether
the proceeds of fraud are taxable. In my view, in the case of a
net worth assessment, the estimates of income must stand or fall
on the basis of the facts as they are actually proven to have
existed in the years under appeal. Here the expenses were, in
fact, overstated by the amounts that were entered in the payroll
ledger and not paid. The bookkeeper's entries have had the
effect of causing those amounts to be added to the income
assessed to Mr. McCarthy. If the assessor had had the correct
information, the assessments would have been for lesser amounts,
and they should now be adjusted accordingly.
[22] The
amounts overstated in the payroll ledger for the three years in
question are the following: In 1992: for Ms. Curtis, $2,312; for
Ms. Duffy, $3,185; for Jo-Anne Burns, $4,520; a total of $10,017,
which I shall round to $10,000. In 1993: for Jo-Anne Burns,
$3,948, and that is the total for that year. In 1994: for Jo-Anne
Burns, $4,841; for Doreen Burns $2,600; for Velma Campbell
$2,784; a total of $10,225. The result, then, for the three years
in question is the following: For the year 1992, there should be
deducted from income by reason of the truck issue, $16,000; by
reason of the overstated loan account balance arising out of the
renovations, $24,401; by reason of the overstatement of wages,
$10,000; a total of $50,401 to be deleted from the income for the
year 1992. For the 1993 taxation year, the overstated value of
the garage of $15,000 is to be deducted; the overstated wage
expense, $3,948 is to be deducted. The total reduction of the
1993 income is $18,948. For the 1994 year, the overstated wage
expense is $10,225. From this should be deducted $5,000 in
respect of the value of the garage which was paid in 1994 but
recorded in 1993. While the Minister may not appeal against his
own assessment for 1994, the smaller amount omitted from income
may be netted against the larger amount wrongly included. The net
reduction of income, therefore, for 1994 will be $5,225.
Penalties were assessed of almost $40,000. Mr. Rouse did not
argue that this was not a case for penalties. The amount of the
penalties should, however, be adjusted to reflect the reduction
in the income for each of the years under appeal. My present view
is that this is not an appropriate case in which to award costs
to either party.
Addendum
[23] After I
delivered these Reasons for Judgment orally on July 13, 2001,
counsel for the parties were given the opportunity to make
submissions as to costs. Neither of them did so, and I therefore
signed judgment allowing the appeals and referring the
assessments back to the Minister for reconsideration and
reassessment in accordance with these Reasons, making no Order as
to costs.
Signed at Ottawa, Canada, this 21st day of August, 2001.
"E.A. Bowie"
J.T.C.C.
COURT FILE
NO.:
98-1745(IT)G
STYLE OF
CAUSE:
Glenn McCarthy and
Her Majesty the Queen
PLACE OF
HEARING:
Fredericton, New Brunswick
DATE OF
HEARING:
July 9, 2001
REASONS FOR JUDGMENT BY: The
Honourable Judge E.A. Bowie
DATE OF
JUDGMENT:
August 3, 2001
APPEARANCES:
Counsel for the Appellant: D. Andrew
Rouse
Counsel for the Respondent: Marcel Prevost
COUNSEL OF RECORD:
For the Appellant:
Name:
D. Andrew Rouse
Firm:
Mockler Peters Oley Rouse & Williams
For the
Respondent:
Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada
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