Schmidt v. The Queen, docket 95-1651-IT-G

Date: 19990127

Dockets: 95-3609-IT-G; 95-1651-IT-G

BETWEEN:

GUNTHER W. SCHMIDT, LORE G. SCHMIDT,

Appellants,

and

HER MAJESTY THE QUEEN,

Respondent.

Appeals heard on June 22, 1998 at Vancouver, British Columbia by the Honourable Judge Gerald J. Rip

Reasons for judgment

Rip, J.T.C.C.

[1] Gunther W. Schmidt and his wife, Lore G. Schmidt appeal from the following assessments of the Income Tax Act ("Act") issued by the Minister of National Revenue ("Minister"):

a) With respect to Mr. Schmidt,

i) assessment issued pursuant to subsection 227.1(1) of the Act, notice of which is dated January 25, 1988 and bears number 534824, for the amount of $13,326,662.34 ("Assessment No. 1");

ii) assessment issued pursuant to subsection 227.1(1) of the Act, notice of which is dated January 25, 1988 and bears number 534826, for the amount of $3,386,875.81 ("Assessment No. 2");

iii) assessment for 1985 issued pursuant to subsections 15(1) and 56(2) of the Act, notice of which is dated February 22, 1988, which includes $272,000[1] in additional income and imposes a penalty under subsection 163(2) of the Act ("Assessment No. 3");

iv) assessment for 1985 issued pursuant to paragraph 6(1)(a) and subsection 56(2) of the Act, notice of which is dated July 20, 1989, which includes $1,200,000 in additional income and imposes a penalty under subsection 163(2) ("Assessment No. 4")[2];

b) With respect to Lore G. Schmidt, the wife of Mr. Schmidt, assessment issued pursuant to section 160 of the Act, notice of which is dated April 12, 1989 and bears number 5847, in the amount of $68,612.60.

[2] All appeals were heard on common evidence. Unfortunately, notwithstanding the amounts of tax in issue and the complexity of the facts, Mr. and Mrs. Schmidt represented themselves without benefit of counsel. It might well be that lack of knowledgeable legal counsel prejudiced their appeals.

MINISTER'S POSITIONS

a) Director's Liability

[3] Assessment No. 1 was the result of QIX Facilities Corporation ("Facilities") failing to pay the balance of $13,326,662.34 of tax assessed under Part VIII of the Act for its 1985 taxation year. Part VIII and section 127.3 provided for scientific research tax credits in 1985. The provisions generally permit a corporation to flow out to investors certain tax benefits the corporation was otherwise entitled to as a result of the corporation incurring costs for scientific research. Assessment No. 2 resulted from QIX Computer Corporation ("Computer") failing to pay $3,386,875.81 of Part VIII tax for its 1985 taxation year. Mr. Schmidt was director of both corporations at all relevant times and, according to the Minister, he failed to exercise the degree of care, diligence and skill to prevent failures of Facilities and Computer to pay the Part VIII tax that a reasonably prudent person would have exercised in comparable circumstances. If the Minister is correct, Mr. Schmidt is liable together with the particular corporation to pay the Part VIII taxes and any interest or penalties relating thereto: subsections 227.1(1) and (3).

b) Assessment No. 3 – Minister's Assumptions

[4] In making Assessment No. 3, the Minister assumed the following facts:

a) On March 26, 1984 Computer was incorporated in British Columbia by the appellant and Wolfgang Zink ("Zink") to perform scientific research and development in respect of a computer system for use in the food irradiation plant in Richmond, British Columbia;

b) At all relevant times, the appellant and Zink were the only directors of Computer, the appellant was the president and Zink was the secretary, and the only shareholders of Computer were the appellant, companies controlled by the appellant and companies controlled by Zink;

c) Prior to November 15, 1985, Computer was controlled by the appellant and other companies controlled by the appellant;

d) From November 15, 1985 onward, Computer was controlled equally by the appellant and other companies controlled by him on the one hand, and by Zink and other companies controlled by him on the other hand;

e) At all relevant times, the appellant and Zink did not deal at arm's length but acted in concert together with a common mind;

f) Isatt Corporation ("Isatt") was incorporated by the appellant and Zink in Las Vegas, Nevada, U.S.A.;

g) In early 1985, the appellant and Zink prepared a draft contract by which Isatt was to supply computer equipment to Computer;

h) This contract was backdated to September 1984 and was never properly executed;

i) The appellant and Zink caused Computer to transfer $630,147US to Isatt;

j) Of these funds, $400,000US was invested in term deposits and the remainder was spent on computer equipment supplied to Computer;

k) In August and September 1985, on instructions from the appellant and Zink, the $400,000US was transferred from Isatt to the Barbados bank accounts of RDM International and Micro Research ($200,000US each) and was immediately transferred back to Vancouver, $200,000US from RDM International to RDM Research and $200,000US from Micro Research to Alpha Micro;

l) Isatt was used only for this one transaction and did not file any U.S. tax returns;

m) In July 1986, the appellant transferred most of the funds in RDM Research's bank account back to the Barbados bank account of RDM International;

n) By means of the transactions described above, the appellant and Zink caused Computer to indirectly transfer funds in the amount of $272,000 ($200,000US x 1.36) to RDM Research at a time when Computer had a liability under Part VIII of the Act of $3,318,367;

o) RDM Research gave no consideration for the $272,000;

p) At all relevant times, none of Computer, Isatt, RDM Research, the appellant, Zink or any company controlled by the appellant or Zink was dealing at arm's length with any other company or individual referred to in the group;

q) The indirect transfer of $272,000 to RDM Research was made pursuant to the direction of, or with the concurrence of, the appellant as a benefit the appellant desired to have conferred on RDM Research which would have been included in the appellant's income as a shareholder of Computer pursuant to subsection 15(1) of the Act if the indirect transfer had been made to him;

r) The appellant, knowingly or under circumstances amounting to gross negligence, made an omission in his income tax return for his 1985 taxation year within the meaning of subsection 163(2) of the Act by failing to include in his income the $272,000 received by RDM Research and the tax payable under subparagraph 163(2)(a)(i) exceeds the tax that would have been payable if computed under subparagraph 163(2)(a)(ii) such that a federal penalty of $23,770.18 was properly levied pursuant to subsection 163(2); and provincial penalty of $11,823.29 was also levied so that total penalties were as follows:

Federal $23,770.18

Provincial $11,823.29

Total $35,593.47

c) Assessment No. 4 – Minister's Assumptions

[5] With respect to Assessment No. 4, the Minister assumed the following facts:

a) On August 29, 1984 Facilities was incorporated by the appellant and Zink to develop a food irradiation plant in Richmond, British Columbia;

b) At all relevant times, the appellant and Zink were the only directors of Facilities, the appellant was the president and Zink was the secretary, and the shareholders of Facilities were companies controlled by the appellant and by Zink's children;

c) At all relevant times, the appellant and Zink did not deal at arm's length but acted in concert together with a common mind;

d) On November 5, 1984, A & A Refrigeration Contractors Inc. ("A & A"), a California, U.S.A. company, incorporated a subsidiary, Alpha Refrigeration Services Inc. ("Alpha"), which contracted with Facilities to supply the refrigeration systems for the project;

e) On February 14, 1985, two directors of A & A, Gerry Linton ("Linton") and Michael Reppas ("Reppas"), signed a resolution authorizing the opening of two bank accounts in A & A's name with the Royal Bank in Vancouver, British Columbia; the appellant had sole signing authority for one of these accounts (the "Schmidt A & A account") and Zink had sole signing authority for the other account (the Zink A & A account");

f) These two accounts were in addition to a third A & A bank account of which two of A & A's directors, Linton and Patrick Hogan ("Hogan"), had joint signing authority;

g) The appellant and Zink had told Linton and Hogan that the additional two accounts were needed so that the appellant and Zink could have control of the funds in order to pay sub-contractors working on the project;

h) On February 12, 1985, the appellant signed two cheques payable by Facilities to A & A for $300,000 each, which were deposited in the A & A account for which Linton and Hogan had signing authority, after which $300,000 was transferred to the Schmidt A & A account and $300,000 was transferred to the Zink A & A account;

i) On May 29, 1985, the appellant signed a cheque payable by Facilities to A & A for $800,000, of which $400,000 was deposited directly in the Schmidt A & A account and $400,000 was deposited directly in the Zink A & A account;

j) On August 2, 1985, the appellant signed two cheques payable by Facilities to A & A for $500,000 each, of which one cheque was deposited directly in the Schmidt A & A account and one was deposited directly in the Zink A & A account;

k) The total amount thus deposited or transferred to the Schmidt A & A and the Zink A & A accounts was $1,200,000 each, held in term deposits and treasury bills;

l) None of these funds were paid to A & A or Alpha for work done in the project;

m) A & A did not receive or know about the cheques for $800,000 or the two cheques for $300,000;

n) On August 16, 1985, the appellant incorporated RDM Research International Inc. ("RDM Research") in British Columbia and Zink incorporated another company in British Columbia, Alpha Micro Research Corp. ("Alpha Micro");

o) On August 19, 1985, bank accounts were opened for RDM Research and Alpha Micro at the Royal Bank in Vancouver, British Columbia;

p) The appellant also incorporated a company in the Barbados called RDM International Inc. ("RDM International") which was controlled by the appellant; Zink also incorporated a company in the Barbados called Micro Research Inc. ("Micro Research") which was controlled by Zink's children;

q) Bank accounts were opened for these two companies at the Royal Bank in Barbados;

r) Between August 27, 1985 and September 4, 1985, on the appellant's and Zink's instructions, the entire amount in the Schmidt A & A account and the entire amount in the Zink A & A account with accumulated interest were transferred, in two installments, to the Barbados bank accounts of RDM International and Micro Research respectively ($1,213,000 each) and immediately returned to Vancouver, without the interest portions, to the bank accounts of RDM Research and of Alpha Micro respectively ($1,200,000 each);

s) By means of the transactions described above, the appellant and Zink caused Facilities to indirectly transfer funds in the amount of $1,200,000 to RDM Research at a time when Facilities had a liability under Part VIII of the Act of about $17,000,000;

t) RDM Research gave no consideration for the $1,200,000;

u) At all relevant times, none of Facilities, A & A, RDM International, RDM Research, the appellant, Zink, Zink's children or any company controlled by these companies or individuals was dealing at arm's length with any other company or individual referred to in this group;

v) The indirect transfer of $1,200,000 to RDM Research was made pursuant to the direction of, or with the concurrence of, the appellant as a benefit that the appellant desired to have conferred on RDM Research and which would have been included in the appellant's income as an employee of Facilities pursuant to paragraph 6(1)(a) of the Act if the transfer had been made to him;

w) The appellant, knowingly or under circumstances amounting to gross negligence made an omission in his income tax return for his 1985 taxation year within the meaning of subsection 163(2) of the Act by failing to include in his income the $1,200,000 received by RDM Research and the tax payable under subparagraph 163(2)(a)(i) exceeds the tax that would have been payable if computed under subparagraph 163(2)(a)(ii) such that a federal penalty of $107,099.91 was properly levied pursuant to subsection 163(2); a provincial penalty of $53,317.39 was also levied so that total penalties were as follows:

Federal $107,099.91

Provincial $ 53,317.39

Total $160,417.30

d) Minister's Application – Rule 58(1)(b)

[6] Prior to the trial of these appeals the respondent's counsel brought a motion to strike out Mr. Schmidt's Amended Notice of Appeal[3] since it discloses no reasonable grounds for appeal within the meaning of rule 58(1)(b) of the Tax Court of Canada Rules (General Procedure) ("Tax Court Rules") and that the appeals from Assessments No. 1 and No. 4 constitute an abuse of the process of the court within the meaning of subsection 53(c) of the Tax Court Rules, based on the doctrine of issue estoppel. These matters were previously decided by another Court and Mr. Schmidt is estopped from having them heard again. The Provincial Court of British Columbia[4] found Facilities and Mr. Schmidt guilty of wilful evasion of tax and the making of deceptive statements in returns of income as a result of overstating the quantum of scientific expenditures. The decision of Craig, P.C.J. was affirmed by the Court of Appeal of British Columbia.[5] Judge Craig summarized the bases of the various charges in his reasons for judgment:[6]

In Count 1 QIX[7] was charged with willful evasion of taxes in the amount of $6,315,603 imposed under Part VIII of the Income Tax Act. Schmidt and Zink were charged as officers, directors or agents of QIX. The specific allegation is that between August 29, 1984, and May 21, 1986, the corporation's expenditures on scientific research within the meaning of section 194(2) of the Act were overstated, thereby resulting in an offence under section 239(1)(d) of the Act.

In Counts 2 and 3 QIX and Schmidt as its officer, agent or director, are charged with making false or deceptive statements in 1985 corporate tax returns under part VIII and Part I respectively. The accused are alleged to have falsely stated expenditures in the amount of $34,700,000 and $35,159,541 in these tax returns for the period August 29, 1984, to September 27, 1985, thereby committing an offence under section 239(1)(a) of the Act. The returns are dated May 14, 1986.

Schmidt is charged alone in Counts 4 and 5, Count 4 is an allegation of willful evasion of taxes under section 239(1)(d) in that between December 31, 1984, and April 15, 1986, Schmidt failed to report as income $1,200,000 appropriated from QIX. Count 5 is under section 239(1)(a) alleging that Schmidt made false or deceptive entries in his 1985 tax return by failing to include $1,200,000 income. Zink is charged in an identical fashion in Counts 6 and 7.

Counts 8, 9, 10 and 11 are identical allegations against QIX with Schmidt and Zink charged as its officers, directors or agents with making false or deceptive entries in the books and records of QIX contrary to section 239(1)(c) of the Act. These counts involve the making of statutory declarations by Zink on January 11, 1985 May 27, 1985, July 11, 1985 and August 30, 1985, in which it was stated that QIX had made or planned to make within 60 days of each declaration a specific amount of expenditures on scientific research, and that this was an entry in the books and records of QIX which was falsely stated.

[7] The amounts on which Mr. Schmidt was convicted, submitted respondent's counsel, included the amount of $13,326,662.34 (which, counsel suggested, is included in the amount of $34,700,000 and $35,159,541 Mr. Schmidt was charged under paragraph 239(1)(a)) and $1,200,000 he was assessed (Assessments No. 1 and No. 4, respectively) pursuant to section 227.1 and paragraph 6(1)(a), as well as the penalty assessed under subsection 56(2).

[8] Attached as an exhibit to the respondent's Notice of Motion were the affidavit of Donald Grant Cowan, an employee of Revenue Canada, copies of reasons for judgment in R. v. Q.I.X. Facilities et al., supra, and Schmidt v. The Queen, supra, and the transcript of the status hearing. Mr. Cowan conducted an investigation of the affairs of Mr. Schmidt, Facilities, Computer and Mr. Zink and has knowledge of the facts he deposed to. He also swore the informations alleging the offences under the Act and attended the trials before the Provincial Court.

[9] In his affidavit Mr. Cowan set out the findings of the Provincial Court, holding Mr. Schmidt and Mr. Zink guilty of the eleven counts of tax evasion and the Court of Appeal's dismissal of the appeals from the judgment of the Provincial Court. In a separate prosecution, Mr. Schmidt, Mr. Zink and Computer were acquitted of the counts of deliberately overstating expenses and Mr. Schmidt was ultimately acquitted of the count of failing to report the amount of $272,000 allegedly appropriated from Computer.[8]

[10] Mr. Cowan describes the facts leading to Mr. Schmidt's convictions and the assessments numbered 1 and 4 to prove issue estoppel; that is, that the same question has been decided by the Provincial Court and the Court of Appeal, that the decisions of the Court of Appeal confirming the decision of the Provincial Court was final and the parties to the decision in their privios were the same persons as the parties to the proceeding in which the estoppel is raised. Much, if not all the facts, described in Mr. Cowan's affidavit are set out in these reasons. Mr. Cowan also explains why and how adjustments were made in preparing the assessments.

[11] At trial Mr. Schmidt commenced reading a prepared presentation but I requested that he produce the document as an exhibit for me to review. This is Exhibit A-1, a lengthy and detailed description, seen through Mr. Schmidt's eyes, and his analysis of events from the time he immigrated to Canada in 1951 to the middle of 1987. The document rambles on at times and much of the material is irrelevant to the issues before me. It is amazing how much detail he purports to remember from this period, in particular from the time during which the events leading to the appeals transpired. I found much of Mr. Schmidt's evidence fanciful or wishful thinking. I believe that over the years he has convinced himself of the existence of facts and events that the British Columbia Courts have found do not exist.

ASSESSMENTS NO. 1 AND NO. 2

a) Mr. Schmidt's case

[12] The essence of Mr. Schmidt's evidence with respect to Assessments No. 1 and 2 is that he put forth his best efforts to make Facilities and Computer successful and all the events leading to these assessments and the other assessments before me were due to the actions of other people, in particular his professional advisors and those of the two corporations.

[13] During his testimony Mr. Schmidt wished, to produce, I inferred, a mass of documents not included in his Partial List of Documents filed pursuant to section 81 of the Tax Court Rules. When respondent's counsel objected to their production, I agreed they ought not be produced. During the course of Mr. Schmidt's argument, however, he indicated he wished to produce only about fifteen other documents. He indicated these documents contained relevant information that was suppressed by the Crown in the earlier criminal proceedings. He also indicated his counsel at the criminal proceedings did not review the documents as assiduously as he should have. I directed Mr. Schmidt to forward copies of these documents to respondent's counsel for him to review with a representative of Revenue Canada. Respondent's counsel would then report to me his opinion of the relevance and importance of the documents and of course Mr. Schmidt would have the opportunity to comment on counsel's observations. I would, of course, review the material independently. Mr. Schmidt delivered a letter containing nine sets of documents to respondent's counsel on or about June 25, 1998 and counsel wrote me with his comments on July 15, 1998. Mr. and Mrs. Schmidt's comments were sent to the Court on August 28, 1998. I have reviewed the material, notwithstanding that the documents have not formally been produced as evidence, and the comments of respondent's counsel and Mr. Schmidt. Some of the documents are hearsay others are not relevant to the issues, and none really helps the appellants. I offer, for what it is worth, a review of the documents and brief comments, which are attached as an appendix to these reasons. Had I found the documents to be of assistance to Mr. Schmidt and Mrs. Schmidt in prosecuting their appeals, I would have ordered the hearing of the appeals be reopened pursuant to section 138 of the Tax Court Rules.

b) Analysis

[14] Based on the evidence before me, I cannot determine that the issue that is the subject of Assessment No. 1 was determined by the Provincial Court. Mr. Cowan's affidavit does not satisfy me that the amount of $13,266,662.34 payable as a Part VIII tax by Facilities was, for purposes of the criminal proceeding, to be included in Mr. Schmidt's income as a result of his inability to prevent the failure of Facilities to pay the tax. There is no direct reference in Mr. Cowan's affidavit to the amount of $13,266,662.34. He does set out in great detail evidence establishing that the $1,200,000 in Assessment No. 4 is the same $1,200,000 Mr. Schmidt was convicted of failing to include in his income for 1985. I cannot, therefore, find that Mr. Schmidt estopped from appealing Assessment No. 1.[9]

[15] The appellant has the onus of proving he met the standard of care imposed by subsection 227.1(3), that is, that he:

... exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances.

[16] In Soper v. The Queen,[10] Robertson, J.A., speaking for the Court, held that for a director to be freed of the personal liability imposed by section 227.1 the standard of care that should be exercised by the director should be assessed on an objective and subjective level. On page 5416 he explains:

... The standard of care laid down in subsection 227.1(3) of the Act is inherently flexible. Rather than treating directors as a homogeneous group of professionals whose conduct is governed by a single, unchanging standard, that provision embraces a subjective element which takes into account the personal knowledge and background of the director, as well as his or her corporate circumstances in the form of, inter alia, the company's organization, resources, customs and conduct. Thus, for example, more is expected of individuals with superior qualifications (e.g. experienced business-persons).

The standard of care set out in subsection 227.1(3) of the Act is, therefore, not purely objective. Nor is it purely subjective. It is not enough for a director to say he or she did his or her best, for that is an invocation of the purely subjective standard. Equally clear is that honesty is not enough. However, the standard is not a professional one. Nor is it the negligence law standard that governs these cases. Rather, the Act contains both objective elements – embodied in the reasonable person language – and subjective elements – inherent in individual considerations like "skill" and the idea of "comparable circumstances". Accordingly, the standard can be properly described as "objective subjective".

[17] The standard, in other words, combines the traditional objective, reasonable standards test with subjective elements such as the individual's intelligence, experience and level of sophistication. Later on, in Drover v. The Queen,[11] Robertson, J.A. acknowledged Soper is not the answer to all questions of director's liability and summarized Soper at page 6380:

... The "objective subjective" standard of care ... focuses on whether the surrounding circumstances are such that a person of the director's ability and business experience was under a positive duty to act as to ensure that the corporation's obligations to remit withholding taxes was fulfilled...

[18] With respect to Assessment No. 1 and Assessment No. 2, Mr. Schmidt says he was not to blame for failures of the corporations to remit tax since the failures resulted from, or were caused by, the actions of others. As director of the two corporations, the appellant says, he exercised the degree of care, diligence and skill to prevent the failures by Facilities and Computer to pay Part VIII tax that a reasonably prudent person would have exercised in comparable circumstances. However, he did not provide any evidence to support his claim of due diligence. His efforts to make the companies successful do not constitute a good "due diligence" defence. There are no cases that support his position. He says that Cooper & Lybrand ("C & L"), the accountants, gave him documents to sign and relying on their professional expertise, he signed those documents for filing with Revenue Canada. He insists the false information on the documents was known to be false by his professional advisors. He does not deal, however, with the fact that the information on the documents originated with the corporations he controlled directly or indirectly by himself or with Zink, that he was actively involved with their activities and that he was aware that the amounts used to calculate scientific research and experimental development tax credits were inflated. That the corporations did not owe any money to Revenue Canada according to the material provided to him by the corporations' accountants, based on information provided to the accountants by the corporations, at the time he signed the tax forms does not assist his position. Similarly, any due diligence performed by the accountants before the doing of transactions does not protect him if the corporations provided false information.

[19] Mr. Schmidt also claims he was wrongly convicted: the Provincial Court of British Columbia came to a wrong conclusion. Mr. Schmidt blamed his lawyers for the conviction. He said they did not realize the importance or relevance of some documents. They did not let him testify. In fact, he said, certain evidence was only "recently discovered". (This includes several documents submitted after the hearing of these appeals which I have discussed earlier.) I must note that during cross-examination Mr. Schmidt's replies were rambling, in particular when he commented on the criminal trial proceedings, and I was unable to ferret out facts that could assist him in his "due diligence" position.

[20] In any event, Mr. Schmidt is a well educated man who has a degree in organic chemistry from the University of Alberta. He had a history of business experience in a company called Canadian Elastileum Limited which he operated with his father Gerhard Schmidt from 1956 to April of 1985. He was the president of both Facilities and Computer. He was actively involved in their day-to-day operations and had an intimate knowledge of the corporate transactions of both companies. Further, the appellant was aware of his obligation to exercise due diligence and, unlike the taxpayers in Cloutier et al. v. M.N.R. 1993 DTC 544, at 550, Mr. Schmidt was in a position to direct the actions taken by the companies.

[21] With respect to Facilities, the Provincial Court and the Court of Appeal each found that Mr. Schmidt knew that the invoices presented to C & L from A & A were artificially inflated in order to increase the amount of scientific research expenditures reported in the statutory declaration and comfort letter from C & L. He knew that this action would result in the release of escrowed funds that would otherwise be diverted towards the payment of the Part VIII tax liability.

[22] The appellant maintains that he relied upon the information conveyed to him by Zink regarding the invoicing and release of funds and that he confirmed this with agents of C & L. However, there is no evidence beyond his assertions to support this contention. Although Zink was the financial officer of Facilities, the appellant had sufficient skill and knowledge of Facilities' operations and the scientific research tax credit program to question the prudence of the actions taken by the company. It is possible that a prepayment to A & A was reasonable in the circumstances and that it was necessary to create separate bank accounts to maintain control over the funds. However, one must question the prudence of later moving these funds away from A & A to a third party company in a foreign country and then to another company in Canada. The appellant maintains that he did not instruct Facilities to directly deposit funds into the A & A bank accounts controlled by him and Zink. However, he states that he did receive all bank statements regarding these accounts and therefore must have been, or should have been, aware that such deposits were made. The appellant says that he was informed that the transfer to Barbados was necessary due to the non-delivery of equipment from a company called ETI, which would inevitably jeopardize the continuation of Facilities' project beyond the deadline. This explanation is questionable given that the funds in question were being held under A & A's name and there is no apparent connection between A & A and ETI. Certainly, the appellant could not have believed that once transferred, these funds would still be used for the payment of A & A's future services, as the funds were completely removed from the control of the company.

[23] The unreasonableness of these transactions combined with the fact, among others, that the British Columbia Provincial and Appeal Courts have found that the appellant knowingly and wilfully participated in deceiving Canada Trust in order to ensure the release of funds confirms that the appellant did not exercise the degree of care, skill and diligence to prevent the failure of Facilities to pay the Part VIII tax that a reasonable prudent person would have exercised in comparable circumstances. Mr. Schmidt is liable for the unpaid Part VIII taxes of Facilities.

[24] The actions of Mr. Schmidt with respect to Computer are also not in keeping with those of a person who exercised any degree of care diligence or skill to prevent Computer from failing to pay Part VIII tax. The appellant testified that there was a contract between Isatt and RDM International to provide technical service related to engineering, chemistry and physics in future developments. However, there is no evidence to support that Isatt was conducting business. The appellant produced Isatt invoices at trial that were prepared by him and Zink with their personal computer. This evidence is suspect given that the appellant was unable to satisfy me that Isatt carried on business. Further, the appellant failed to advance a reasonable explanation as to why Computer paid Isatt $400,000US in excess of the cost of the computer equipment and services provided by Isatt. He stated that these funds were later transferred to RDM International and Micro Research pursuant to a contract of service entered between the companies. However, as mentioned earlier, there is little evidence to support the existence of such a contract. And if such a contract did exist, one must question the reason two corporations were used to provide identical services. Mr. Schmidt was indifferent to either his or any corporation's duties, obligations or liability under the Act. The appellant cannot succeed with the due diligence defence available pursuant to subsection 227.1(3).[12]

ASSESSMENTS NO. 3 AND NO. 4

a) Appellant's Case

[25] With respect to Assessments No. 3 and 4, Mr. Schmidt again produced no proper evidence to suggest that any assumption of fact relied on by the Minister in assessing was wrong. He did submit a copy of reasons for judgment of the Court of Appeal of British Columbia, dated January 3, 1991,[13] which quashed his conviction by the Provincial Court, and ordered a new trial. He had appealed from a count, among others, that he failed to report in his 1985 tax return $272,000 of income appropriated from Computer, and committed an offence contrary to paragraph 239(1)(d) of the Act.

[26] The allegation against Mr. Schmidt in the Provincial Court was that he directed, or concurred in, the payment of money by Computer to Isatt and the transfer of $200,000US from RDM International to RDM Research. The Crown's position was that Mr. Schmidt was taxable under subsection 56(2) of the Act. In his reasons for judgment, the trial judge relied on the Federal Court of Appeal reasons for judgment in R. v. McClurg.[14] The Federal Court of Appeal, he concluded, held that subsection 56(2) does not apply in the context of a corporation. The Court of Appeal of British Columbia opined that the applicability of subsection 56(2) depends on the facts of each case. The Court of Appeal of British Columbia also stated that there was no evidence that Mr. Schmidt was a shareholder of Computer. At the new trial,[15] Mr. Schmidt was found not guilty by Judge McGivern of the Provincial Court of British Columbia. McGivern, P.C.J. held there was reasonable doubt that funds were appropriated by Mr. Schmidt or that he intended to evade payment of tax. On the facts in the appeals at bar, the Minister assumed, when assessing, that Messrs. Schmidt and Zink were the only shareholders of Computer and Mr. Schmidt did not prove that this fact was wrong.

b) Respondent's Position

[27] The Deputy Attorney General submits that the Assessments No. 3 and 4 are correct. The Minister included the amounts of $272,000 and $1,200,000 in Mr. Schmidt's income for 1985 pursuant to subsection 56(2) of the Act since these amounts were indirectly transferred to RDM Research from Computer and Facilities respectively, pursuant to his direction or with his concurrence, as a benefit Mr. Schmidt desired to have conferred on RDM Research and which would have been included in his income as a shareholder of Computer pursuant to subsection 15(1) and as an employee of Facilities pursuant to paragraph 6(1)(a) respectively, if the transfers had been made to him.

c) Appellant's Position and Analysis: Assessment No. 3

[28] Mr. Schmidt took the position that the transfers of $272,000 by Computer to Isatt, then to RDM International and eventually to RDM Research were bona fide business transactions and the funds were properly acquired by RDM Research as a loan from RDM International. In 1985, subsection 56(2) read as follows:

A payment or transfer of property made pursuant to the direction of, or with the concurrence of, a taxpayer to some other person for the benefit of the taxpayer or as a benefit that the taxpayer desired to have conferred on the other person shall be included in computing the taxpayer's income to the extent that it would be if the payment or transfer had been made to him.

[29] Thus, for subsection 56(2) to apply: a) an actual transfer or payment must be made to a person other then the taxpayer, b) the payment or transfer must be at the direction of, or with the concurrence of the taxpayer, c) the payment or transfer must be for the taxpayer's benefit, or as a benefit he wished to confer on another, and d) the payment or transfer would have been included in the taxpayer's income if it had been paid to him.[16]

[30] In the facts resulting in Assessment No. 3, the $272,000 was paid by Computer to Isatt pursuant to a contract and then transferred to RDM International and then to RDM Research. These transfers were made at the direction or concurrence of Mr. Schmidt. Although Mr. Schmidt may not have actually directed the payment to Isatt he was aware of the contract between Isatt and Computer and the financial obligations under it. The facts before me are that Isatt appears to have been incorporated for this single transaction and the contract price was $400,000US in excess of the equipment and services provided. There was no real commercial reason to pay the excess amount and it appears the funds were paid to Isatt in order to move the funds from Computer to Isatt. Mr. Schmidt was a director and shareholder of Isatt. He was aware of the corporation's activities. Further, he was the sole shareholder of RDM International. On the balance of probabilities he was reasonably aware of the transfer of $200,000US from Isatt to RDM International. The appellant directed or concurred with the transfer of the funds from RDM International to RDM Research; he was the individual involved in the operation of these companies. Consequently, the first two requirements have been met for the application of subsection 56(2).

[31] The amount of $272,000 ($200,000US) was paid to RDM Research. The payment was a benefit to that company. It is also an indirect benefit to the appellant as he was the sole shareholder of RDM International, the parent company of RDM Research since he could ultimately direct the companies to pay these funds out to himself, thereby benefiting himself.

[32] Had Computer paid the $272,000 directly to the appellant, the amount of $272,000 would have been conferred as a benefit to Mr. Schmidt as a shareholder and would be included in his income under subsection 15(1) of the Act. Subsection 15(1) is designed to tax individuals on benefits they receive by virtue of their status as a shareholder. The direct payment of an amount by Computer to the appellant would be included in the appellant's income. There is no evidence to suggest that the appellant provided consideration to Computer or that the payment was part of a bona fide business transaction. The remaining two requirements for subsection 56(2) to apply are present at bar.[17]

[33] I cannot agree with Mr. Schmidt that the transfer of funds between Computer and ultimately RDM Research was a bona fide business transaction. Although there was a purported contract for service between Computer and Isatt, the business purpose of the contract is suspect since Computer paid $400,000US in excess of the cost of the computer equipment and services provided by Isatt. Mr. Schmidt could not explain to my satisfaction the reason for the excess costs. There is no evidence, other then the appellant's testimony, to suggest that a bona fide contract for service existed between Isatt and RDM International. The $400,000US was divided between RDM International and Zink's corporation, Micro Research. The appellant testified that both corporations were established to provide technical support to Isatt but he could not explain the reason two corporations, rather than one, was created for this purpose. The appellant also stated that RDM International loaned these funds to RDM Research, its Canadian subsidiary, and that this is the reason the funds were later transferred back to the Barbados company in July of 1986. Again, there is no evidence to support the existence of such an intercorporate loan.

[34] The facts leading to Assessment No. 3 appears to be a series of empty transactions designed with the sole purpose of moving funds away from Computer, which had a substantial tax liability, to a company that the appellant indirectly controlled. The appellant, it appears, treated the assets of Computer and RDM Research, among other corporations, as his own, to do with as he wished. The transfer of funds to RDM Research was a benefit to the appellant within the meaning of the Act, as he could ultimately direct the funds to be paid out to himself as the sole shareholder of RDM International, the parent company of RDM Research. Consequently, the $272,000 should be included in the income of the appellant.

[35] Mr. Schmidt fought his appeals with vigor, but with insufficient ammunition. He did not produce any evidence which could lead me to conclude that Assessment No. 1, 2 and 3 are wrong. The facts before are essentially the facts assumed by the Minister when making the assessments. In Hickman Motors Limited v. The Queen,[18] L'Heureux-Dubé, J., observed that;

It is trite law that in taxation the standard of proof is the civil balance of probabilities: Dobieco v. M.N.R., [1966] S.C.R. 95, and that within balance of probabilities, there can be varying degrees of proof required in order to discharge the onus, depending on the subject matter: Continental Insurance v. Dalton Cartage, ]1982] 1 S.C.R. 164; Pallan v. M.N.R., 90 DTC, 1102 (T.C.C.) at 1106. The Minister, in making assessments, proceeds on assumption (Bayridge Estates v. M.N.R., 59 DTC 1098 (Ex. Ct.), at p. 1101) and the initial onus is on the taxpayer to "demolish" the Minister's assumptions in the assessment (Johnston v. M.N.R., [1948] S.C.R. 486; Kennedy v. M.N.R., 73 DTC 5359 (F.C.A.), at p. 5361). The initial burden is only to "demolish" the exact assumption made by the Minister but no more: First Fund Genesis v. The Queen, 90 DTC 6337 (F.C.T.D.), at p. 6340.

The initial onus of "demolishing" the Minister's exact assumptions is met where the appellant makes out at least a prima facie case: Kamin v. M.N.R., 93 DTC 62 (T.C.C.); Goodwyn v. M.N.R., 82 DTC 1679 (T.R.B.)...

[36] Mr. Schmidt has not demolished the Minister's assumptions. He has not made a prima facie case for himself that the assessments he is appealing from are wrong. The Minister's assumptions have not been contradicted or challenged by any reasonable and proper proof. The facts assumed by the Minister to be true continue to be the true facts.

c) Assessment No. 4

[37] The appeal from Assessment No. 4, respondent's counsel argues, is based on facts identical to those heard and dismissed by Craig P.C.J. and Mr. Schmidt is therefore estopped from having the matter heard again. There was nothing that Mr. Schmidt stated or produced in evidence in the appeals at bar that raise any serious doubt as to the findings of Craig P.C.J.

[38] Assessment No. 4 was made pursuant to subsection 56(2) and paragraph 6(1)(a) of the Act.

[39] With regards to subsection 56(2), in order for estoppel to apply it must be determined that the criminal proceedings addressed whether a payment or transfer of property in the amount of $1,200,000 was made pursuant to the appellant's directions to another person for the benefit of either the appellant or that person. Both the trial judge and the Court of Appeal of British Columbia held that such a transfer did take place.

[40] A & A was a U.S. corporation operating in the state of California. On November 5, 1984 it incorporated a subsidiary called Alpha, which subsequently entered into a contract with Facilities to provide refrigeration systems. In February of 1985, Mr. Schmidt and Zink convinced the directors of A & A to establish two corporate bank accounts for the purposes of paying the subcontractors. The rationale behind this decision was the fact that Facilities had to spend a fixed amount of money during the taxation year in order to qualify for a scientific research tax credit. Hence, the appellant and Zink proposed to make payments to A & A for its services, including those of the subcontractors, in advance and to place these funds in separate A & A bank accounts. Two accounts were established in A & A's name with the appellant having sole signing authority on one account and Zink having sole authority on the other. The appellant and Zink then issued a number of cheques to A & A which were deposited in equal amounts to the two accounts, $1,200,000 each. One of these cheques was originally passed through A & A's general corporate account into the individual accounts, but the remaining cheques were deposited directly into the appellant's and Zink's accounts without the knowledge of A & A's directors.

[41] In the meantime, Mr. Schmidt incorporated RDM Research in Vancouver, and RDM International in Barbados. Zink incorporated Alpha Micro in Vancouver and Micro Research in Barbados. All of these new companies established bank accounts in their respective countries.

[42] Craig, P.C.J. and the Court of Appeal of British Columbia found as a matter of fact that between the period of August 27, 1985 and September 4, 1985, the appellant and Zink transferred the funds in their respective A & A accounts to the bank accounts of the companies they established in Barbados, which in turn transferred the funds to the bank accounts of RDM International and Alpha Micro in Vancouver. Hence, the appellant and Zink effectively transferred $1,200,000 each from Facilities to RDM International and Alpha Micro, respectively, thereby preventing Facilities from paying its Part VIII tax liability.

[43] Judge Craig found the appellant guilty of failing to report income of $1,200,000 appropriated from Facilities and of making false and deceptive entries in his 1985 tax return by failing to include this income.[19] At the Court of Appeal, Legg, J. stated at page 5328 that:

In my opinion, the learned judge was clearly correct when he held that the charges against Schmidt and Zink of failing to report $1,200,000 of income in the 1985 tax returns and of failing to include that sum in their stated total of income had been established beyond a reasonable doubt.[20]

[44] The Provincial Court found that Mr. Schmidt wilfully made a false statement in his tax return regarding his income and is guilty of an offence pursuant to section 239 of the Act.[21] Craig, P.C.J. found that a transfer of $1,200,000 had been made under the appellant's direction or concurrence to RDM Research for the benefit of the company and therefore that amount should have been included in the appellant's income. These are the issues before me. These are the facts before me. Accordingly issue estoppel is applicable to Assessment No. 4 and that it would be an abuse of process pursuant to Rule 53(c) of the Tax Court Rules to hear an appeal from that assessment.[22] I cannot accept Mr. Schmidt's claim that the proceedings before the Provincial Court were fraught with perjury and professional incompetence. There is simply no suggestion that Mr. Schmidt's submissions on this matter are valid and compel me to rehear this issue.

PENALTIES

[45] Assessments No. 3 and 4 also include penalties assessed under subsection 163(2) of the Act. The Minister considered that Mr. Schmidt

...knowingly, or under circumstances amounting to gross negligence in the carrying out of any duty or obligation imposed by or under the [the] Act, ... made or ... participated in, assented to or acquiesced in the making of, a false statement or omission in a return, ... filed or made in respect of [1985] as required by or under [the] Act or a regulation...

and is therefore liable to a penalty. The Minister submits that Mr. Schmidt filed to include in income the amount of $272,000 with respect to Assessment No. 3 and the amount of $1,200,000 with respect to Assessment No. 4; the penalties assessed pursuant to subsection 163(2) were the amounts of $23,770.17 and $107,099.91 respectively.[23] The facts brought forth by the respondent, including the judgments of Judge Craig of the Provincial Court and the Court of Appeal, are sufficient to justify the assessment of the penalty in Assessment No. 4. Mr. Schmidt was aware that the amount of $1,200,000 ought to have been included in his income and he deliberately set forth not to do so.

[46] With respect to the penalty included in Assessment No. 3, I am satisfied that on the balance of probability Mr. Schmidt knowingly, or under circumstances amounting to gross negligence, failed to include the sum of $272,000 in his income. However, a court of competent jurisdiction, the Provincial Court of British Columbia, held that there was reasonable doubt Mr. Schmidt intended to evade payment of tax with respect the amount of $272,000. McGivern, P.C.J. considered whether Mr. Schmidt committed an offence described in paragraph 239(1)(d) of the Act, that is, whether he;

wilfully, in any manner, evaded or attempted to evade, compliance with this Act or payment of taxes imposed by this Act ...

[47] The Minister, in assessing a penalty under subsection 163(2), has the burden of establishing the facts justifying the assessment of the penalty: subsection 163(3). In assessing the penalty the Minister relied on the facts he assumed to be correct in when he included the amount of $272,000 in Mr. Schmidt's income. The assessment of the penalty is a penal sanction. The onus of proof is a higher standard that in a civil penalty. Mr. Schmidt was faced with a decision of the Provincial Court with respect to the penalty included in Assessment No. 4; the Minister was faced with a decision of the Provincial Court with respect to the penalty included in Assessment No. 3. Mr. Cowan's affidavit does not assist the respondent on this issue. The Minister's burden to justify the penalty is therefore compounded by a finding of a court that Mr. Schmidt did not evade or attempt to evade tax on the amount of $272,000. The Minister did not succeed in justifying the penalty.

APPEAL OF MRS. SCHMIDT

[48] As far as Mrs. Schmidt's appeal is concerned there is no evidence before me that even suggests the assessment is suspect. Mrs. Schmidt, as I appreciate the evidence, is a good and loyal wife who at the beginning of her marriage worked to support the family and has been a constant source of support to Mr. Schmidt.

[49] In 1961 Mr. and Mrs. Schmidt purchased a residence. The home was registered in the names of both Mr. and Mrs. Schmidt. Mrs. Schmidt testified she paid for the residence, but she could not provide any corroboration. This is not surprising since the transaction took place over thirty-five years ago. The property was registered in both names. She said the price of the home was $15,900 which was acquired by a loan of $14,250, secured by a first mortgage. There was also a second mortgage that was paid off in two years. Mrs. Schmidt testified the first mortgage was repaid over twenty-five years and that both she and Mr. Schmidt made payments.

[50] By deed dated February 14, 1986 and registered on February 17, 1986 Mr. Schmidt transferred his interest in the home to Mrs. Schmidt for one dollar. One-half of the market value of the property at time of transfer was $75,000, according to the deed.

[51] A document submitted by the appellant in argument chronicles none too clearly various events purportedly related to the transfer of Mr. Schmidt's interest in the Schmidt residence.

[52] According to this document, Mr. Schmidt's father purchased property in Richmond, British Columbia in 1956. Mr. Schmidt and his father commenced carrying on business together in 1956; they became equal partners in 1968. In 1984 Computer was incorporated. In August 1984 Mr. Schmidt's father transferred one-half of his fee simple in the Richmond property to Mr. Schmidt and they then owned the property as joint tenants. Facilities commenced business in September 1984. It appears the business was carried on from the Richmond property. In August 1985 there appears to be a charge registered on the property. At the time Mr. Schmidt's father transferred a one-half interest in the Richmond property to Mr. Schmidt, Mrs. Schmidt testified, the father requested Mr. Schmidt to transfer his interest in the residence he owned with Mrs. Schmidt to Mrs. Schmidt. This is the subject transaction of the assessment. There are other events described in the document as well, much of which are unsubstantiated and, to me at least, a little confusing. In any event, there is nothing I could find in the evidence to indicate that Mr. Schmidt's one-half interest in the family residence was not owned by him or had a value of less then the $69,000 estimated by the Minister.

[53] Section 160 states that where a person has transferred property, directly or indirectly, to his or her spouse, the transferee (the spouse) and the transferor (the person) are jointly and severally liable to pay part of the transferor's tax for each taxation year. If the transferee paid value to the transferor for the property transferred, his or her liability would be reduced accordingly. There is nothing in the evidence or the appellant's submissions that would reduce her liability under section 160. What may have taken place between the husband and the father-in-law, indeed, between her and her father-in-law is of no help to her in this appeal.

[54] The appellant has not established that the assessments for tax of Mr. Schmidt were in error or that the aggregate of all amounts Mr. Schmidt was liable to pay under the Act or in respect of the taxation year in which he transferred his interest in the residence to Mrs. Schmidt or any preceding year was less than $177,967.32, as alleged by the Minister.

JUDGMENTS

[55] The appeals of Mr. Schmidt from Assessments No. 1, 2 and 4 are dismissed. His appeal from Assessment No. 3 is allowed and referred back to the Minister of National Revenue for reconsideration and reassessment only for the purpose of deleting the penalty assessed pursuant to subsection 163(2) of the Act. By order of Rowe, D.J.T.C.C., appellant Gunther W. Schmidt was exempted from paying any fees pertaining to the institution and conduct of his appeals up to the commencement of the hearing of the appeals. Mr. Schmidt and counsel for the respondent are requested to make representations by March 5, 1999 whether the appellant Gunther W. Schmidt should be entitled to further relief in forma pauperis or should he be ordered to pay costs for the hearing of his appeals.

[56] Mrs. Schmidt's appeal is dismissed with costs.

Signed at Ottawa, Canada, this 27th day of January 1999.

"Gerald J. Rip"

J.T.C.C.

APPENDIX TO REASONS FOR JUDGMENT

[Omitted]

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