Gerrimar Holdings Ltd. v. The Queen, docket 98-1247-IT-G

Date: 19990923

Dockets: 98-1247-IT-G; 98-1248-IT-G

BETWEEN:

GERRIMAR HOLDINGS LTD., JIM MAZURSKI,

Appellants,

and

HER MAJESTY THE QUEEN,

Respondent,

Reasons for Judgment

Mogan J.T.C.C.

[1] The appeals of Gerrimar Holdings Ltd. v. The Queen (Court file 98-1247) and Jim Mazurski v. The Queen (Court file 98-1248) were heard together on common evidence. The issued shares of Gerrimar Holdings Ltd. were held equally by Jim Mazurski and his wife Rita Mazurski. For convenience, I will refer to Gerrimar Holdings Ltd. as the "Company" and will refer to Mr. Mazurski as "Jim". The Company owns and operates the Queen's Hotel in Dominion City, Manitoba, a small settlement of about 350 people, 90 kilometres directly south of Winnipeg and approximately 15 kilometres north of the U.S. border. The Company is appealing from income tax assessments in respect of its fiscal periods ending the 30th day of June, 1993 and 1994. Jim is appealing from income tax assessments with respect to the calendar years 1992, 1993 and 1994. The assessments under appeal were issued on the basis that the Company had failed to report part of its income, and that Jim had appropriated from the Company all or part of the unreported income. The issue is a factual question.

[2] Jim is 53 year of age with a Grade 8 education and Grade 12 vocational training. In his working life, he started out doing stucco and plastering but changed to what he called "a drywaller". In 1989, he was working as a drywaller when he was asked by a friend (Mr. Cassidy) if he would take on the job of managing the Queen's Hotel in Dominion City, Manitoba. He accepted the job and started managing the hotel around December 1989. It was his first experience as a hotel manager and also his first experience at keeping a set of books for a business. According to his unchallenged evidence, he and his wife did almost all of the work in and around the hotel. He took a complete shift in the bar; he did the ordering; he hired staff; and he assisted in the renovations. His wife Rita managed the restaurant which could accommodate over 50 people and was part of the hotel. Jim was paid a salary of $1,500 per month for managing the hotel. He described the hotel as a "dive" in 1989; it was badly rundown with the carpets ripped and the furniture in poor repair. He did the best he could managing the hotel from 1989 to 1992 when Mr. Cassidy asked him if he would like to buy it. Jim and Rita decided to buy the hotel and they caused it to be purchased by the Company.

[3] Immediately after the purchase, they embarked upon an ambitious plan to renovate the hotel. At the time of purchase, it had 22 small guest rooms which were approximately eight feet by thirteen with only two washrooms upstairs, one for men and one for women. When the renovations were completed in 1993 or 1994, the 22 small rooms had been consolidated into nine larger rooms, five of which had private bathrooms. The remaining four guest rooms were grouped in pairs so that one pair shared a bathroom and the other pair shared a different bathroom. Jim hired local skilled trades (electricians and plumbers) to perform certain parts of the renovations but he also did some of the drywalling himself.

[4] The hotel restaurant has a capacity for 51 persons and the bar has a capacity for 121. During the years under appeal there were four video lottery terminals ("VLTs") in the bar but, in recent years, there have been six VLTs in the bar. Rita is primarily responsible for operating the restaurant and Jim is primarily responsible for operating the rest of the hotel. The restaurant is open from 7:00 a.m. to 5:30 p.m. Monday to Friday and from 8:00 a.m. to 8:00 p.m. on Saturday and from 8:00 a.m. to 2:00 p.m. on Sunday. The bar is open from 11:00 a.m. to 2:00 a.m. six days a week Monday to Saturday. Jim opens the bar at 11:00 o'clock in the morning and works there until approximately 4:30 in the afternoon when a part-time employee takes over the bar until 9:00 o'clock in the evening. Between 4:30 and 9:00 o'clock in the afternoon and early evening, Jim has his supper and has a short sleep. He then returns to the bar at 9:00 o'clock and runs it until 2:00 in the morning when it closes.

[5] The income tax assessments under appeal arose under the following circumstances. The Company had been filing corporate tax returns each year from 1989. For the fiscal periods ending June 30, 1992, 1993 and 1994, the liability side of the balance sheet showed the following shareholder advances:

Fiscal Period Shareholder Advances

June 30, 1992 $19,384

June 30, 1993 $49,390

June 30, 1994 $72,853

The shareholder advances from 1992 to 1993 grew by $30,006 and from 1993 to 1994 grew by a further $23,463. Revenue Canada noted the growth in the shareholder advances and also noted that Jim and his wife were reporting only modest income in the same three taxation years as follows:

Taxation Year Jim's Salary Rita's Salary

1992 $6,250 $7,741

1993 $6,000 $6,000

1994 $6,000 $6,000

[6] Upon reviewing the Company's income tax returns for the fiscal periods ending 1993 and 1994, Revenue Canada could not understand how the shareholder advances to the corporation could grow by $30,006 in 1993 and $23,463 in 1994 when Jim and his wife together were earning only $12,000 or $13,000 as salaries from the Company. Accordingly, Revenue Canada sent an auditor, David Cherrett, from Winnipeg down to Dominion City to meet with Jim and to review the books and records of the Company. Mr. Cherrett testified as a witness at the hearing of these appeals. He stated that he found the books and records of the Company generally in a good state. Jim assured Mr. Cherrett that he did not have any outside source of income. In other words, neither Jim nor his wife had any outside investment income or any pension. They were living on only the salary and wages they drew from the Company. As shown in paragraph 5 above, each was earning in the range of $6,000 or $7,000 a year. When Mr. Cherrett asked where the money came from to increase the shareholder advances by $30,000 in 1993 and a further $23,000 in 1994, Jim told him that the fresh capital invested in the Company came from his VLT winnings. According to Jim, he was very successful at playing the VLTs and made enough money over the first three years owning the hotel to support the additional investments in the hotel shown by the increased shareholder advances on the Company's balance sheet.

[7] The assessments under appeal are based on the simple fact that Mr. Cherrett did not believe Jim's story of VLT winnings. Having rejected Jim's story, Mr. Cherrett was left with an unexplained source of Jim's increased investment in the Company. He therefore decided to perform what is commonly called a "net worth" of Jim to see if he could determine any change in Jim's net worth over a particular period. The statement of net worth of Jim Mazurski appears as Schedule A to the Respondent's Reply to Jim's Notice of Appeal and to the Company's Notice of Appeal. The statement of Jim's net worth shows that his net worth increased from 1991 to 1994 in the following amounts:

1992 $10,743

1993 $50,558

1994 $31,602

Total $92,903

[8] Although that statement of net worth was not put into evidence, its content is not disputed by Jim. Counsel for both Appellants stated that she was not disputing any of the items in the statement of net worth as evidence of an increase in Jim's net worth from 1991 to 1994. She accepted the fact that there was an increase in net worth but her position is that any increase in net worth, over and above the salaries paid to Jim and Rita by the Company in the relevant years, was attributed solely to Jim's winnings on the VLTs located in the hotel.

[9] Attached as Schedule B to the Respondent's Reply to the Company's Notice of Appeal is a document entitled "Restatement of Income Per Net Worth" in which Revenue Canada has apparently attempted to restate the Company's income during the fiscal periods ending June 1992, 1993 and 1994 assuming that Jim's increase in net worth was in fact derived from unreported sales of the hotel. Again, this Schedule B was not put into evidence but it was not disputed by the Appellants other than their overall proposition that there were no unreported sales in the Company's income tax returns as filed; and that any increase in the Jim's net worth was derived from his VLT winnings. And lastly, as Schedule C to the Respondent's Reply to the Company's Notice of Appeal there is a reconciliation of Jim's net worth and the Restatement of the Company's income out of which Revenue Canada concluded that the Company had unreported sales of the following amounts in its two fiscal periods under appeal:

June 30, 1993 $27,776

June 30, 1994 $59,014

[10] The above conclusions of Revenue Canada (whether accurate or not) and the overall defence of the Appellants are confirmed in the following allegations of fact appearing in the Company's Amended Notice of Appeal:

4. Pursuant to Notices of Reassessments both dated January 27, 1997, the Minister of National Revenue reassessed the Appellant with respect to its 1993 and 1994 taxation years and in so doing increased the Appellant's income for each of the 1993 and 1994 taxation years by $27,776 and $59,014, respectively, on the basis that the Appellant had unreported income.

6. The amounts of $27,776 and $59,014 added to the income of the Appellant in respect to the Appellant's 1993 and 1994 taxation years was not income of the Appellant but rather were video lottery terminal winnings of Jim Mazurski which were loaned by Jim Mazurski to the Appellant.

The Respondent admitted paragraph 4 but denied paragraph 6.

[11] Schedule C to the Respondent's Reply to the Company's Notice of Appeal shows a reconciliation between the total increase in Jim's net worth ($92,903) for his three taxation years under appeal with the Company's discrepancy in earnings in the aggregate amount of $86,790 for its two fiscal periods ending in June 1993 and 1994. As seen from the pleadings quoted above, the Appellants do not dispute the content of the statement of Jim's net worth but the Appellants both claim that any apparent increase in net worth is attributable solely to Jim's VLT winnings. By contrast, Revenue Canada claims that any increases in net worth to Jim were derived from unreported sales in the Company's business, and that such unreported sales were appropriated by Jim. Accordingly, the Company has been assessed on the basis that it has failed to report all of its income and Jim has been assessed on the basis that he, as a 50% shareholder, has appropriated substantial amounts of money from the Company.

[12] Subsection 163(2) of the Income Tax Act provides a penalty for any taxpayer who knowingly has made a false statement in his return of income. Intending to apply this provision of the Act, Mr. Cherrett recommended that penalties be levied against both Jim and the Company with respect to the assessments which are under appeal. In his oral testimony at the hearing, Mr. Cherrett stated that his recommendation was approved by his supervisor and that penalties were intended to be levied against both Jim and the Company. Through some error in processing the assessments, the penalty against Jim was omitted but a penalty was levied against the Company. Mr. Cherrett stated that this was an error because a penalty should have been assessed against Jim for the same reason that it was assessed against the Company. Revenue Canada decided, however, that it would not reassess Jim just for the purpose of imposing a penalty. Therefore, Jim is appealing only in respect of the increase in his income resulting from the alleged shareholder appropriation under section 15 of the Act; and the Company is appealing with respect to both the increase in its income resulting from the alleged unreported sales and also the penalty under subsection 163(2) of the Act.

[13] As might be expected having regard to the issue in these two appeals, all of the evidence was directed to the questions of whether Jim won significant amounts from the VLTs in the hotel. Because the increase in his personal net worth was the cornerstone of the assessments issued against him and the Company, he was required to explain the source of the following amounts which were added to his reported income in his taxation years under appeal:

1992 $10,743

1993 $50,558

1994 $31,602

Total $92,903

[14] The amounts added to Jim's income in those three years are, in the aggregate, significantly larger than the increases in his shareholder advances to the Company which were $30,006 in the Company's fiscal period ending June 1993 and an additional $23,460 in the Company's fiscal period ending June 1994. It was those increases in the shareholder advances which triggered the audit of Jim and the Company which in turn resulted in a determination of Jim's net worth. The assessments against Jim were therefore based on the net worth statement and not on the increases in his shareholder advances to the Company. His appeal was argued by his counsel on the basis of the aggregate amount of $92,903; and I will allude to that later in these reasons for judgment. See paragraphs 33 and 34 below. I make this statement now only for the purpose of demonstrating that Jim had the onus of proving that his net winnings from the VLTs in the hotel in the three years under appeal were not less than $92,903.

[15] As the first witness for the Appellants, he described his acquisition of the hotel (already referred to above) and his routine in managing the hotel. Basically, Jim's wife Rita runs the restaurant and Jim runs the bar. They have only two or three employees who work primarily as a waitress in the restaurant or a bartender to spell off Jim and also a person who cleans the guest rooms, if necessary, and does general cleaning around the hotel including the washrooms. Although the bar opens at 11:00 o'clock in the morning, there are hardly any patrons in the afternoon or evening on the first four days of the week but the patrons increase on Friday and Saturday evenings. Jim will ordinarily order beer once a week but, if he runs short, he can call the Manitoba Liquor Commission ("MLC") and get a special order. Because liquor is more expensive, he orders it on an "as needs" basis. As the operator of a licensed bar, he is required to complete quarterly reports for the MLC. In the early 1990s, the MLC would send an inspector in on a monthly basis usually to check for underage drinkers. Jim stated that he and the hotel have never had any problem with the MLC inspectors except that they did require renovations in certain areas.

[16] Jim had no bookkeeping experience prior to his coming to the hotel as manager but he described the manner in which he cashed out at the end of each day. There were four basic sources of revenue for the hotel: the restaurant, the bar, the VLTs and guest rooms. Jim's wife Rita would do the day-end tally for the restaurant and he would do it for the bar, the VLTs and the guest rooms. Exhibit A-1 is a collection of statements of account for the MLC showing the purchases by the Queen's Hotel over a series of many months commencing in July 1993. Exhibit A-2 is a series of cash sheets as prepared by Jim at the end of each day. Although the documents in Exhibit A-2 are entitled "Restaurant Cash Sheet" he in fact used them to record his sales in the bar and the VLT proceeds. Exhibit A-3 is a large number of daily VLT reports for all of 1994. Each report shows the amounts of money paid into the VLTs on a daily basis; the amounts paid out on a daily basis; and certain other amounts including a final "today's net" for each day. The amount of each day's "net" is allocated 80% to the Manitoba Lotteries Foundation and 20% to the hotel. The sheets in Exhibit A-3 appear to run from January through to December 1994. They can be identified with 1994 because the "today's net" for January 4 is $655.50 and that is the amount shown in Exhibit A-2 as the VLT total for January 4, 1994.

[17] Jim's evidence with respect to his playing the VLTs and his winnings is not complicated. The VLTs are located in the bar and the bar is open six days a week Monday to Saturday from 11:00 o'clock in the morning until 2:00 o'clock the following morning. The bar is generally quiet the first four days of the week (Monday to Thursday) because Dominion City is a community of only 350 people. It is necessary, however, that Jim be on duty in the bar when it is open and he therefore has many hours of quiet time when there are no customers in the bar. On those days, he states that he would play the VLTs from two hours to four hours between afternoon and evening. Also, he will have an opportunity to play Friday up until late afternoon when the bar starts to get busy. It is his practice not to play the VLTs when there are customers in the bar. When he decides to play, he takes $20 out of his wallet and exchanges it for loonies; and then starts to play the loonies in the VLTs. According to his testimony, he is consistently successful and wins as much as $80 to $100 a day.

[18] It is relevant to understand what happens when a customer wins at a VLT. According to the evidence of Jim and other witnesses, the VLTs are something like slot machines in the sense that there are reels of symbols which spin around when a coin is inserted and come to a rest hopefully in a pattern which will indicate that the customer has won. When a customer wins, a bank of lights goes on at the top of the machine and there is a sign indicating that the customer can either cash the winnings or receive a credit for the amount of the winnings. The winnings could be a relatively modest amount like $20 or a large amount as high as $1,000. If the customer decides to use the credit, the customer can continue playing the machine without putting in any further coins until the amount of the credit has been used up in plays or until the customer wins some additional amount while using part of the credit from the prior win.

[19] If the customer decides to cash the winnings and not use the credit to play the VLT, the customer is required to press a certain button stating that he or she wishes to cash out; and the machine will then print out a cash slip indicating the amount of the winnings. The customer takes the cash slip from the machine and goes to the operator of the bar to present the slip for payment. The person operating the bar will run the cash slip through a verifying machine to verify the amount of the win, the date of the win, the machine at which the win was obtained and some other relevant information. If the customer's cash slip satisfies the requirements of the verifying machine, the person operating the bar will then keep that slip but pay the winning amount to the customer. According to the evidence of Jim and one or two employees of the hotel who testified, the hotel has no further use for the winning slip tendered by the customer and it is simply stored in a box under the bar.

[20] When Mr. Cherrett arrived at the hotel in 1995 to commence his audit on behalf of Revenue Canada, he asked Jim about the increase in shareholder advances to the Company and was told that the source of the additional advances was Jim's winnings at the VLTs. At that time, Jim had no record of his winnings or any other documents indicating how often he played the machines or when he won or what amounts he won. Mr. Cherrett was simply asked to take it as a matter of faith that the increased capital invested in the Company came from VLT winnings. Mr. Cherrett's audit continued from 1995 to 1996 while he assembled the information necessary to determine any change in Jim's net worth from 1991 to 1994. The reassessments under appeal were not actually issued until January 1997.

[21] During the course of the audit, there must have been some discussion between Jim and Mr. Cherrett or between Jim and his professional advisors concerning the absence of any documentation to prove the extent of his playing VLTs and the extent of his winnings. For whatever reason, Jim commenced in 1996 to save what he claimed were the winning vouchers issued to him by the VLTs every time he won. There was a considerable volume of these winning VLT vouchers assembled by Jim. Some time prior to the hearing of these appeals, his alleged winning VLT vouchers for 1996 and 1997 were made available to Revenue Canada. Although these VLT vouchers were for 1996 and 1997 (after the years under appeal) they appear to have been offered to Revenue Canada as evidence of the consistency with which he won at the VLTs.

[22] For the reasons set out below, I have concluded that Jim's claim that his admitted increase in net worth was the result of VLT winnings is not believable. His claim is not reasonable. Indeed, it is preposterous.

[23] Some of Jim's own documents do his case more harm than good. Exhibit R-3 is a photocopy of his claimed VLT winning slips for April 1996. Exhibit R-5 is a photocopy of his claimed VLT winning slips for May 1996. Exhibits R-6 and R-7 are photocopies of his claimed VLT winning slips for December 1996 and February 1997, respectively. These exhibits were presented to Jim on cross-examination and, on closer inspection, produced some surprising results. For example, according to Exhibit R-3, on April 16, 1996 at 2:14:24 in the afternoon Jim won $100. Forty-two seconds later at 2:15:06 at a different machine Jim won $77.75. Three days later on April 19, 1996 at 2:15:06 in the afternoon Jim won $133.75. Eleven seconds later at 2:15:17 at a different machine Jim won $69.50. According to Exhibit R-5, Jim had four very rapid wins in the month of May 1996. On May 3, 1996 at 11:09:52 in the morning he won $62.50 and then 54 seconds later at 11:10:46 he won $30. On May 25 at 2:15:02 in the afternoon he won $67.75 and then one second later at 2:15:03 at a different machine he won $15.50. On May 30, 1996 at 2:48:54 in the afternoon he won $35.00 and then eight seconds later at 2:49:02 he won $100. Also on May 30, 1996 at 2:15:03 in the afternoon he won $28.75 and then two seconds later at 2:15:05 he won $18.50 at a different machine. When asked in cross-examination how he could explain these rapid winnings just a few seconds apart at different machines Jim's explanation was that he must have been playing two machines at the same time. This is possible but it would certainly stretch one's concentration.

[24] According to Exhibit R-6, on December 27, 1996 at 12:44:21 noon Jim won $75.00 and then 43 seconds later at 12:45:04 he won $25.00 at a different machine. According to Exhibit R-7, on February 1, 1997 at 2:15:02 in the afternoon he won $104.50 and then fifteen seconds later at 2:15:17 he won $5.75 at a different machine. Under cross-examination, Jim acknowledged that all of the games on the various VLTs were games of chance. There was no skill involved. He acknowledged that winning or losing was a matter of pure luck. Having regard to the many rapid wins which appear in Exhibits R-3, R-5, R-6 and R-7 and Jim's claim that they were all his wins, I conclude that when assembling the winning slips in those exhibits he simply used at random winning slips surrendered by hotel customers. The uncontradicted evidence is that all winning slips surrendered for payment to the person running the bar were stored in a box under the bar and were not required by the hotel for any further bookkeeping purposes. Jim ran the bar more than any other person.

[25] If I were to believe Jim's testimony, I would have to accept the fact that he spent at least two hours a day (he says two to four hours) playing the VLTs; that he won more than he lost; and that in the three-year period 1992, 1993 and 1994 his winnings exceeded his losses by $92,903 (see paragraphs 7 and 13 above). For two reasons, I do not believe that Jim spent at least two hours a day playing the VLTs. First, he was managing a hotel with gross revenue of $428,000 and $402,000 in the fiscal years ending June 30, 1993 and 1994, respectively. And second, Jim and Rita had combined salaries of $12,000 in 1993 and in 1994. In those years, they were living in a 1,400 sq. ft. dwelling within the hotel and raising three children who were 15, 12 and 9 years of age in 1993. Jim did not have the time or the money to play VLTs for two to four hours each day.

[26] Exhibit R-1 consists of approximately 50 sheets of paper which are daily VLT reports prepared by Jim. Each page covers two six-day periods representing two weeks of operation. On each day, there is a total for the money paid into the VLTs and the money paid out producing in the right-hand column an amount entitled "today's net". The today's net is added up for the six operating days of each week to make a total; and then the total is allocated 80% to the Manitoba Lotteries Foundation and 20% to the hotel. Jim would know from preparing these reports that each VLT turns in a profit which contributes to the overall weekly profit which in turn permits the hotel to participate in those profits to the extent of 20%. In other words, Jim knew or ought to have known that the hotel was a consistent winner from the amounts paid by the various customers into the VLTs. With that knowledge, he would know or should know that he was going against the odds by playing the VLTs for two to four hours each day in the expectation of beating the game.

[27] There were four witnesses who testified on behalf of Jim to offer credibility to his claim that he was winning significant amounts from playing the VLTs. Jim's wife Rita testified. She described her duties managing the restaurant and also stated that she saw her husband playing the VLTs much of the time. She stated that she knew how to validate a VLT win slip and that she had from time to time cashed out win slips for certain customers but not for her husband. Margaret Pott is a waitress at the Queen's Hotel. She has been living in or around Dominion City most of the time since 1967. She started working in the kitchen of the hotel around 1985 and later became a waitress. Sometimes she works in the bar. She said that she had seen Jim playing the VLTs and that she sometimes played them herself but she tended to lose. She agreed with counsel for the Respondent in cross-examination that the VLTs were based on pure luck with no skill and that they were simply games of chance.

[28] Helen Penner is a retired women living in Dominion City. She worked at the hotel in the 1980s and still goes there almost every day as a customer to drink coffee and play the VLTs. On occasion, she is still a casual part-time worker at the hotel. She said that she does not know how many machines are in the hotel now; she said perhaps six or seven. She said that Jim wins more often than she did. Her evidence as to Jim playing the VLTs and his winning came out after a somewhat prodding examination-in-chief. Sharon Hancock is a present employee of the Queen's Hotel. She is a waitress and a bartender and has lived in Dominion City for about 30 years. She does not play the VLTs because she thinks it is like throwing money away but she said that she did know that Jim played. She also said that she had been there when Jim or his wife had won at the VLTs but, on those occasions, she was a customer in the bar and not an employee and so she did not know how they "cashed out".

[29] These four women (Rita Mazurski, Margaret Pott, Hilda Penner and Sharon Hancock) testified to corroborate Jim's evidence that he was a frequent player of the VLTs and that he was a frequent winner. They could hardly be classified as objective witnesses because Rita is his wife and the other three were either full-time or casual employees in the hotel. Each one dutifully went to the witness stand and, in one case, with a little prompting, stated that Jim played the VLTs. I put very little weight on the evidence of any of the four women with regard to whether Jim was a frequent player or winner at the VLTs.

[30] The Respondent called as a witness Remy Brengman who is general manager of the VLT Division of the Manitoba Lotteries Foundation. Mr. Brengman has worked for the Foundation since 1985. He explained that VLTs are placed only in licensed age-restricted bars. They are hooked up to a central system for accounting and payout and operating hours. It is the Manitoba Lotteries Foundation which establishes the time to shut down the machines. In each VLT there is an E-pron (erasable, programmable memory chip) which is not controlled by the central system. Somehow, this E-pron has an effect on the percentage of money that can be won from a particular machine.

[31] Mr. Brengman said that $1,000 is the most that can be won at any one time from a particular VLT. He also stated that there are approximately 5,300 VLTs in Manitoba which brings in net proceeds of $200,000,000 a year to the Manitoba Government. Of particular interest in these appeals was his evidence that each machine is, in theory, programmed to pay back as winnings approximately 90% of the money paid into the machine but that, in practice, each machine pays back as winnings approximately 70% of the money paid in. I inferred from one of his answers that if a large group of people at the beginning of a particular day collectively had $1,000,000 and started to play VLTs without adding any fresh money over and above the original $1,000,000 the VLTs over a period of time would end up with all of the $1,000,000. The effect of Mr. Brengman's evidence is that from a statistical point of view, it is most improbable that any person like Jim could consistently win by playing the VLTs. I draw the opposite conclusion that if a person played the VLTs extensively over a period of two or three years at the rate of two or three hours a day, that person would lose a significant amount of money.

[32] On the question of Jim's credibility, I have already stated that I do not believe his story of VLT winnings. That story was not corroborated by any independent witness to whose testimony I can attach weight. That story was not corroborated by any diligent record-keeping on Jim's part. That story was undermined by the evidence of Mr. Brengman whose testimony persuades me that any individual playing the VLTs regularly over a long period of time will not be a winner. And lastly, that story was not corroborated by the photocopies of VLT winning slips which were entered as Exhibits R-3, R-5, R-6 and R-7. I have described how, if Jim's story were to be believed, and if those tickets really were his winnings in 1996 and 1997, then there would be many occasions when he won at two different machines within a few seconds as if he were playing two machines at once. I am forced to conclude that those tickets were not Jim's winnings but were simply retained from the many winning tickets which he cashed for his customers.

[33] Exhibit R-15 is a document produced by Mr. Brengman from the records of the Manitoba Lotteries Foundation showing the total amounts paid in and paid out of the VLTs at the Queen's Hotel in Dominion City for the calendar years 1992, 1993 and 1994. Exhibit R-15 shows that the VLTs in the Queen's Hotel paid out the following aggregate amount of winnings in those three years:

Amounts paid out

1992 $270,668

1993 $385,775

1994 $406,236

Counsel for the Appellants argued that the amounts added to Jim's reported income for the years under appeal (which he claims were VLT winnings) represented a very modest fraction of the total amounts paid out of the VLTs in the hotel for those years. Counsel put to me in argument the following fractions (Jim's claimed winnings over total amounts paid out) with the corresponding percentages to demonstrate that Jim was not winning a disproportionately high share of the total winnings paid out by the machines in his hotel:

1992 $10,743

$270,668 4%

1993 $50,558

$385,775 13%

1994 $31,602

$406,236 7.7%

[34] I do not accept the above argument as put by the Appellants' counsel because it is based on the assumption that Jim wins every time he plays a VLT. That assumption has to be wrong. There must be many times when he loses. Therefore, in 1992 for example, for every dollar that Jim lost in the VLTs, he had to win a dollar before he reached the point where he was winning an excess of $10,743 over his losses for that year. If I assume as I must that Jim would lose some money in the VLTs in each year, then I have to conclude that his winnings in each year would exceed the amounts actually added to his reported income as a result of the net worth because his aggregate winnings would have to make up for all the dollars that he lost before there would be a positive amount representing the increase in his net worth. In other words, if his claim is true, the amounts of his VLT winnings in each of the years 1992, 1993 and 1994 must have exceeded the amounts added to his reported income for those years as a result of the net worth (see paragraphs 7 and 13 above). This would mean that his percentage of the winnings paid out of the VLTs in the hotel in each year would have been much higher than the percentages shown in the table in paragraph 34 above. An unlikely occurrence.

[35] The Appellants called as a witness Robert McKenzie, the outside accountant for the hotel who had prepared the Company's financial statements for all relevant years. Mr. McKenzie defined gross profit margin as the excess of gross revenue over cost of sales divided by the gross revenue. Applying that formula to the three fiscal periods of the Company ending in 1992, 1993 and 1994, Mr. McKenzie calculated that the Company had a gross profit margin of 37% in 1992, 33% in 1993 and 30% in 1994. If the amounts which Revenue Canada added to the Company's reported income for its fiscal periods ending in 1993 and 1994 were added to the Company's gross revenue as unreported sales, I am satisfied that the Company would not have had an unreasonably high gross profit margin for either one of those two years.

[36] These appeals come down to a choice between the Appellants' claim that any increase in Jim's net worth from 1991 to 1994 was a result of his VLT winnings and Revenue Canada' claim that his increase in net worth was derived from unreported sales in the Company which he appropriated. As already noted, there is no dispute between the parties as to the fact that Jim's net worth increased by $92,903 from the end of 1991 to the end of 1994. Having regard to that admitted increase in net worth, Jim's explanation is not reasonable, not probable and not believable. In those years, the Company had gross revenue in excess of $400,000 but a net profit of less than $1,400 in each of 1993 and 1994. Having regard to Jim's modest salary and the Company's meagre profits, it is reasonable, probable and believable that Jim's admitted increase in net worth was derived from unreported sales in the Company which he appropriated.

[37] I dismiss the Company's appeals for 1993 and 1994 and uphold the assessments on the basis that the Company had unreported sales in those years of $27,776 and $59,014, respectively. I also uphold any penalty levied against the Company under subsection 163(2) of the Income Tax Act. Jim's appeals for his taxation years 1992, 1993 and 1994 are dismissed. The Respondent is entitled to costs in these appeals as if there were only one Appellant but the Respondent shall be entitled to additional costs in the amount of $200 with respect to the pleadings for the second Appellant.

Signed at Ottawa, Canada, this 23rd day of September, 1999.

"M.A. Mogan"

J.T.C.C.