Date: 20010522
Docket: 2000-3574-IT-I
BETWEEN:
ROBERT Z.S. URPESZ,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Bowman, A.C.J.
[1]
These appeals are from assessments for 1994 and 1995. Both the
appellant's representative, Mr. Follwell, and counsel
for the Minister inform me that the assessments are for nil tax
as a result of the application of losses from other years under
section 111 of the Income Tax Act.
[2]
The assessments were not put in evidence although they were
attached to the notices of appeal and they do assess nil tax for
each year, although the taxable income for 1994 is $13,226.
[3]
The sole issue is therefore the imposition of penalties under
subsection 163(2) of the Act. I asked counsel for the
statutory basis upon which a penalty may be imposed where no tax
is assessed, given that the penalty is a percentage of the
additional tax assessed on the unreported income.
[4]
Counsel referred me to paragraph 163(2.1)(c) which he
says has the effect of preventing a reduction of the
understatement of income by losses from other years under
section 111. Whether the provision accomplishes what counsel
says it is designed to accomplish is something that I need not
consider since I have concluded that the respondent has not met
the onus imposed upon her under subsection 163(3) of
justifying the penalties.
[5]
Counsel also conceded that the Minister has not on assessing
after the objection reassessed for 1994 to reduce the penalties
by $8,149 as stated in the T7W-C form accompanying the
notice of assessment.
[6]
The notices of assessment do not indicate the amount of the
penalties or indeed that penalties were being assessed.
Paragraph 9(j) of the reply states, inter alia, that
penalties for 1994 and 1995 were assessed in the amounts of
$1,655.25 and $258.30. Just how the Minister can state in the
1994 T7W-C form
Subsection 163(2) penalties are to be reduced by $8,149
when the reply says that all he assessed was $1,655.25 is
something of a mystery. Is the Minister promising a credit of
$8,149 - $1,655.25 or $6,493.75 that can be carried forward
against future omissions?
[7]
At the very least the reduction promised should completely
eliminate the penalty imposed for 1994 leaving only a penalty of
$258.30 for 1995 in issue. I suspect that what was meant was that
the penalty would be reduced as a result of reducing the income
by $8,149.
[8]
The appellant carried on business in 1994 and 1995 as a used car
dealer. Up to July 26, 1995 a business was carried on as
North East Car Sales in Lindsay, Ontario. On November 20,
1995 another used car business was started by the appellant at a
different location as Country Auto Sales.
[9]
The audit originally resulted in an increase in sales by
$45,889.17 for 1994, made up of sales invoices, auto sales
deposits, vinyl sales and lease sales. For 1995 the auditor found
unreported sales of $24,354.77.
[10] After
further representations were made the unreported sales were
reduced by the auditor for 1994 to $22,486.81 and for 1995 to
$6,317.12. On objection the unreported sales for 1994 were
reduced by $8,149 to $14,337.81.
[11] The
auditor also disallowed a number of expenses but this
disallowance did not form the basis of any penalty and was not
challenged.
[12] The
auditor, Ms. L. Borland, was called as a witness. I found
her credible, conscientious and thorough and I can find no
criticism of the manner in which she conducted the audit. She
worked under extreme difficulty. The books of the appellant were
not in good order and the appellant was not co-operative. Indeed
if his conduct in court was any indication of his treatment of
the auditor during the audit he was offensive.
[13]
Ms. Borland compared the reported sales with other evidence
of sales and leases and based her finding on the discrepancy
between the sales reported and the total sales as determined by
her.
[14] I cannot
criticize this method of proceeding in raising an assessment of
tax. An assessor can rely on such evidence, hearsay or otherwise,
as is available and if the taxpayer disagrees he or she can
appeal and must accept the onus of proving the assessment of tax
wrong.
[15] In
establishing the correctness of an assessment of penalties under
subsection 163(2) different rules prevail. Under
subsection 163(3) the respondent has the onus of proving all
necessary constituent elements under subsection 163(2). This
includes proving the amount of the understatement of income, the
correctness of the amount of penalty and the fact that the
understatement was made knowingly or in circumstances amounting
to gross negligence.
[16] I asked
counsel what evidence he relied upon in support of the penalty.
His answer was that the appellant's records were inadequate.
This is not evidence of gross negligence. He did not suggest that
the alleged understatements of income were made knowingly. He had
the appellant in the witness stand and could have cross-examined
him on this point. His cross-examination should have been
searching and thorough. It was perfunctory and desultory. It did
not touch on the alleged understatements disclosed by
Ms. Borland, nor on the circumstances in which they were
made. Ms. Borland had laid the groundwork upon which the
respondent might have built a case for imposing penalties but
there was no follow-up.
[17] The rule
was stated by Lord Hershell in Browne v. Dunn, (1893)
6 R 67, at 70-71:
Now, my Lords, I cannot help saying that it seems to me to be
absolutely essential to the proper conduct of a cause, where it
is intended to suggest that a witness is not speaking the truth
on a particular point, to direct his attention to the fact by
some questions put in cross-examination showing that that
imputation is intended to be made, and not to take his evidence
and pass it by as a matter altogether unchallenged, and then,
when it is impossible for him to explain, as perhaps he might
have been able to do if such questions had been put to him, the
circumstances which it is suggested indicate that the story he
tells ought not to be believed, to argue that he is a witness
unworthy of credit. My Lords, I have always understood that if
you intend to impeach a witness you are bound, whilst he is in
the box, to give him an opportunity of making any explanation
which is open to him; and, as it seems to me, that is not only a
rule of professional practice in the conduct of a case, but is
essential to fair play and fair dealing with witnesses. Sometimes
reflections have been made upon excessive cross-examination of
witnesses, and it has been complained of as undue; but it seems
to me that a cross-examination of a witness which errs in the
direction of excess may be far more fair to him than to leave him
without cross-examination, and afterwards to suggest that he is
not a witness of truth, I mean upon a point on which it is not
otherwise perfectly clear that he has had full notice beforehand
that there is an intention to impeach the credibility of the
story which he is telling.
[18] It was
essential to the Crown's case that the appellant be
challenged on cross-examination on the alleged unreported sales
and the reason for the alleged understatement. Failure to do so
was fatal.
[19] The only
authority counsel gave me was a 1979 decision of the Tax Review
Board (Lahaie v. M.N.R., 79 DTC 743).
[20] As it
happens, the authorities on this branch of the law are legion.
One might start with the numerous pages under
subsection 163(2) of the Act in the CCH Canadian Tax
Reporter or the DeBoo Canada Tax Service. A recent case is
Farm Business Consultants Inc. v. The Queen,
96 DTC 6085, in which the Federal Court of Appeal
upheld a decision of this court (95 DTC 200). At
pages 205-6 this court said:
I am cognizant of the fact that
subparagraph 152(4)(a)(i) has as its purpose the
opening up of returns for statute-barred years where items of
income, for a wide variety of reasons, are omitted or misstated,
whereas subsection 163(2) is a penal provision and that in
applying it if there is doubt as to the type of conduct to which
the misrepresentation is attributable the benefit of that doubt
should be given to the taxpayer. In Udell v. M.N.R., 70
DTC 6019 Cattanach, J. said at page 6025:
There is no doubt that section 56(2) is a penal section. In
construing a penal section there is the unimpeachable authority
of Lord Esher in Tuck & Sons v. Priester, (1887) 19
Q.B.D. 629, to the effect that if the words of a penal section
are capable of an interpretation that would, and one that would
not, inflict the penalty, the latter must prevail. He said at
page 638:
We must be very careful in construing that section because it
imposes a penalty. If there is a reasonable interpretation which
will avoid the penalty in any particular case, we must adopt that
construction.
and at page 6026:
I take it to be a clear rule of construction that in the
imposition of a tax or a duty, and still more of a penalty if
there be any fair and reasonable doubt the statute is to be
construed so as to give the party sought to be charged the
benefit of the doubt.
See also Holley v. M.N.R., 89 DTC 366 at 369; De Graaf
v. The Queen, 85 DTC 5280.
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.3 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.4 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.
_________________
3 Cf. Continental Insurance Co. v. Dalton Cartage
Co., [1982] 1 S.C.R. 164; 131 D.L.R. (3d) 599; 25 C.P.C. 72,
per Laskin, C.J.C. at 168-171; D.L.R. 562-564; C.P.C. 75-77;
Bater v. Bater, [1950] 2 All E.R. 458 at 459; Pallan et
al. v. M.N.R., 90 DTC 1102 at 1106; W. Tatarchuk Estate v.
M.N.R., [1993] 1 C.T.C. 2440 at 2443.
4 This is not simply an extrapolation from the rule in
Hodge's Case (1838) 2 Lewin 227; 168 E.R. 1136,
applicable in criminal matters such, for example, as section 239
of the Income Tax Act where proof beyond reasonable doubt
is required. It is merely an application of the principle that a
penalty may be imposed only where the evidence clearly warrants
it. If the evidence is consistent with both the state of mind
justifying a penalty under subsection 163(2) and the absence
thereof — I hesitate to use the words innocence or guilt in
these circumstances — it would mean that the Crown's
onus had not been satisfied.
[21] I have
obtained great assistance in this matter from two decisions of
Strayer J. in Venne v. The Queen,
84 DTC 6247 and De Graaf v. The Queen,
85 DTC 5280. None of the cases I have mentioned were
referred to by counsel.
[22] At
page 6256 in the Venne decision Strayer J.
said:
With respect to the possibility of gross negligence, I have with
some difficulty come to the conclusion that this has not been
established either. "Gross negligence" must be taken to
involve greater neglect than simply a failure to use reasonable
care. It must involve a high degree of negligence tantamount to
intentional acting, an indifference as to whether the law is
complied with or not. I do not find that high degree of
negligence in connection with the misstatements of business
income. To be sure, the plaintiff did not exercise the care of a
reasonable man and, as I have noted earlier, should have at least
reviewed his tax returns before signing them. A reasonable man in
doing so, having regard to other information available to him,
would have been led to believe that something was amiss and would
have pursued the matter further with his bookkeeper.
[23] What
emerges from these and other authorities is that in proving the
appropriateness of a penalty under subsection 163(2) it is
wholly inadequate for Crown counsel to attempt to prove on the
basis of hearsay evidence some understatement of income, refrain
from cross-examining the person to whom it is sought to attribute
gross negligence and adduce no evidence of gross negligence.
[24] The Crown
has simply not made out a case for penalties.
[25] The
appeals are allowed and the penalties imposed under
subsection 163(2) for the 1994 and 1995 taxation years are
deleted. The appellant is entitled to his costs, if any, in
accordance with the tariff.
Signed at Ottawa, Canada, this 22nd day of May 2001.
"D.G.H. Bowman"
A.C.J.
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