REASONS
FOR JUDGMENT
Graham J.
[1]
Centrepoint Foods Corporation owned and operated
a Saint Cinnamon franchise in a mall in Kingston, Ontario. John Stathopolous
owned 75% of the shares of Centrepoint. The remaining 25% of the shares were
owned by his wife. The Minister of National Revenue reassessed Centrepoint’s
taxation years ending January 31, 2006 and 2007 and its GST reporting periods
from January 1, 2005 to June 30, 2009. The Minister also reassessed
Mr. Stathopolous’ 2005, 2006 and 2007 tax years. Centrepoint and Mr.
Stathopolous have appealed those reassessments. They made a number of
concessions at the beginning of the trial. As a result of those concessions,
only the following remain in issue in these Appeals:
a)
the denial of $58,918 and $70,845 in expenses
claimed by Centrepoint in its taxation years ending January 31, 2006 and 2007 respectively
and the denial of input tax credits relating to those denied expenses in the
corresponding reporting periods;
b) the assessment of shareholder benefits under subsection 15(1) of the
Income Tax Act against Mr. Stathopolous in the amounts of $16,332 and
$17,694 in his 2006 and 2007 tax years respectively;
c)
the assessment of additional net tax relating to
supplies made by Centrepoint that were allegedly treated as zero rated supplies
instead of taxable supplies; and
d) the assessment of gross negligence penalties under subsection 163(2)
of the Income Tax Act or section 285 of the Excise Tax Act on all
of the above.
[2]
I will deal with the first three issues
separately. I will consider the application of gross negligence penalties as
part of my analysis of each issue.
Denied Expenses
and Related Input Tax Credits
[3]
The Minister denied various expenses (and the
related input tax credits) claimed by Centrepoint because Centrepoint failed to
provide the Minister with adequate documentation to support those expenses. The
Minister advised Centrepoint of the amount of expenses that had been allowed
for each supplier and made assumptions of fact that the remaining expenses had
not been incurred or were personal expenses. In order to demolish those assumptions
of fact, Centrepoint needed to either provide me with clear documentation
showing that the expenses had been incurred and were not personal or, at the
very least, provide me with detailed oral testimony explaining the nature of
the expenses in question and explaining why documentation was not available.
Centrepoint did neither of these things. It introduced very little documentary
evidence. The evidence that it did introduce was not specific to the expenses
that had been denied and I was not provided with any guidance as to how the
evidence demolished the assumptions. The oral evidence provided by Mr.
Stathopolous did not provide any greater level of clarity. With the exception
of the expenses that the Minister had classified as being personal, Centrepoint
did not identify the denied expenses either individually or by broad category. Based
on the foregoing, I find that Centrepoint failed to demolish the assumptions of
fact made by the Minister. Accordingly, the denied expenses and the related
input tax credits will not be adjusted.
[4]
Having concluded that I will not be adjusting
the denied expenses and the related input tax credits, I must then consider
whether the gross negligence penalties on those amounts should be upheld. I
conclude that they should not be upheld.
[5]
The CRA auditor, Robert Melka, was called as a
witness by the Appellant. I found him to be a credible witness. Mr. Melka
explained that he had reviewed the bank statements, cancelled cheques and
receipts provided to him by Centrepoint, had allowed those expenses that he was
able to verify and had denied those expenses that he was unable to verify. He
testified that he was not provided with a copy of Centrepoint’s general ledger
or with the accountant’s working papers. He indicated that if he had had access
to those documents he may have been able to verify the denied expenses. Mr.
Melka and his team leader decided that the best way to prompt Centrepoint to
obtain the requested information was to issue a letter proposing both to deny the
expenses and to impose penalties. He testified that he fully expected that,
when Centrepoint received that proposal letter, it would provide him with the
necessary documents. When Centrepoint failed to respond to the proposal letter,
the Minister issued reassessments. Centrepoint did not provide any additional
information to CRA Appeals. As a result, the reassessments were confirmed.
[6]
The overall impression that I have from Mr.
Melka’s testimony is that he did not necessarily believe that all of the denied
expenses had not been incurred but, absent proof that they had, he denied them.
I had the sense that he had seen some information about many of the expenses
but that it was not sufficient information to support a deduction. For example,
he may have seen a cancelled cheque payable to a supplier but not have seen the
supporting invoice.
[7]
The primary argument put forward by the
Respondent for upholding the penalties was the lack of documentation to support
the expenses. Centrepoint’s general ledger was not entered as an exhibit at
trial. While some of the accountant’s working papers were filed as exhibits, no
witness explained them. Mr. Melka testified that he had reviewed the working
papers the evening before trial and that the information contained therein did
not provide sufficient verification for him to change his mind on denying the
expenses. In any event, the working papers were somewhat meaningless without
the underlying general ledger as it was not possible to see what entries the
adjusting journal entries in the working papers were adjusting and whether
those adjustments had, in fact, been made. No invoices or receipts were filed
as exhibits nor were they explained. Other than the cheques relating to the
expenses classified as personal expenses that the Respondent entered into
evidence, no cancelled cheques were entered into evidence nor were the nature
of the expenses that were paid by cheque explained. During the trial, the agent
for Centrepoint referred on numerous occasions to the fact that he had
documentary evidence to support each expense that had been claimed. At least
twice he held up what appeared to be a sample bundle of receipts or invoices.
However, despite my clear instructions to him that he needed to introduce into
evidence any documents that he wanted me to rely upon in reaching my decision,
he introduced none of those documents.
[8]
The Respondent would like me to draw an adverse
inference from Centrepoint’s failure to introduce documents at trial and conclude
that the relevant documents would not have supported Centrepoint’s position. I
am unwilling to do so. The strong impression that I received during the trial
was that the reason that the documents were not introduced was not because
there was a conscious decision on the part of Centrepoint not to introduce
them, but rather because the Appellants’ agent simply did not appreciate that
it was essential to do so.
[9]
In summary, while the lack of documentation is
sufficient to uphold the denial of the expenses, given my conclusions as to why
the documentation was not entered into evidence and as to Mr. Melka’s
expectations as to what the documentation may have shown if it had been
produced, I am unwilling to uphold the gross negligence penalties.
Shareholder
Benefits
[10]
The shareholder benefits assessed against Mr.
Stathopolous represent a subset of the overall expenses denied to Centrepoint.
Mr. Melka testified that, when reviewing the denied expenses, he identified
ones that appeared to be personal and treated them as shareholder benefits. He
explained that, while the shareholder loan that Centrepoint owed to Mr. Melka
had decreased in the years in question, without the general ledger and
accountant’s working papers he could not tell whether that decrease was a
result of Centrepoint accounting for the personal expenses or not.
[11]
Since the shareholder benefits are a subset of
the denied expenses, Mr. Stathopolous’ appeal of those benefits suffers
from the same problems with documentation that plagued Centrepoint in respect
of the denied expenses. He has simply failed to introduce sufficient evidence
to demolish the Minister’s assumption of fact that the expenses in question
were personal. As a result, the shareholder benefits assessed against him will
not be adjusted.
[12]
Having concluded that I will not be adjusting
the shareholder benefits, I must then consider whether the gross negligence
penalties on those benefits should be upheld. I conclude that they should not
be upheld for the same reason that I concluded that they should not be upheld
in respect of the denied expenses. In addition, I note that the accountant’s
working papers do contain some adjustments to the shareholders loan account
that, if the adjustments and the individual expenses that make up those
adjustment had been properly explained and traced through to the general ledger,
could have shown that Mr. Stathopolous did not receive any shareholder benefits.
Additional
Taxable Supplies
[13]
Mr. Melka testified that the amount of GST that
Centrepoint had collected appeared to be very low for the amount of supplies
that it had reported. He accepted that the total supplies were accurately
stated but he had concerns about whether the GST had been properly collected.
Accordingly, he sought to verify how the GST collected had been determined.
[14]
Centrepoint recorded all of its sales from its
Saint Cinnamon franchise using a point of sale system. The Z-tapes from that system
show the total sales for each day and the total GST collected. The Z-tapes do
not show individual sales. Thus Mr. Melka could not use the Z-tapes to verify
how GST was calculated on each individual sale. The point of sale system would
have generated electronic records of each individual sale. Centrepoint either
did not keep the electronic records of those individual sales or was unwilling
to provide them to the Minister.
Thus, the Mr. Melka had no way of determining whether GST was being properly calculated
on individual sales. As a result, Mr. Melka needed another method of
determining whether the GST collected was accurate.
[15]
Mr. Melka made two sample purchases at
Centrepoint’s Saint Cinnamon franchise in order to see how GST was being
calculated. One purchase was for less than $4.00 and the other was for more
than $4.00. Mr. Melka explained that, at the time, provincial Retail Sales Tax
(“RST”) was not charged on prepared food purchases of less than $4.00. When Mr.
Melka examined the receipts that he had received from his purchases, he noted
that RST was clearly identified on the receipt for the purchase costing more
than $4.00, that RST was not charged on the receipt for the purchase costing
less than $4.00 and that GST was not identified on either receipt. I will refer
to these purchases as the “Sample Purchases”. The Sample Purchases reinforced
Mr. Melka’s suspicions that GST was not being properly calculated on individual
sales.
[16]
Mr. Stathopolous testified that the cost of the
items shown on the receipts for the Sample Purchases included GST. I do not
accept his explanation for three reasons. First, I find it unlikely that a
point of sale system would break out RST on a receipt but include GST in the
purchase price in a business where there would be purchases where one or both
taxes may not have applied. Second, Mr. Stathopolous was evasive when he
was asked if he had ever taken any steps to verify that the prices on the
receipts were GST included. Finally, Mr. Stathopolous gave an example of
the price before GST that he said would have been applicable for one of the
items purchased in the Sample Purchases. If the price he testified to had been
accurate, the rate of GST that would have had to have been applied to reach the
supposed GST included price shown on the receipt would have been more than 14%
at a time when the actual GST rate was 5%.
[17]
In order to test his suspicions that GST was
being under-collected, Mr. Melka determined the approximate number of coffee
cups that Centrepoint purchased in its reporting periods from January 1, 2005
to December 31, 2006, calculated an average beverage price for those cups and
applied GST to the resulting estimated revenue. This rough analysis showed a
significant discrepancy between the amount of GST collected and the amount that
one would expect to have been collected. I will refer to this rough analysis as
the “Cup Analysis”. The Cup Analysis indicated that the total GST collected by
Centrepoint on all of its sales was only 57% of the GST that should have been
collected on hot beverage sales alone, let alone sales of cold beverages,
cinnamon buns and other prepared foods.
[18]
Given the results of the Cup Analysis and the
Sample Purchases, Mr. Melka determined that it was appropriate to use an
alternative method to calculate the amount of GST that Centrepoint should have
collected and to expand his audit to also cover the period from January 1, 2007
to June 30, 2009.
[19]
Faced with an assessment arising from an
alternative method, Centrepoint has the choice of either proving that its
records were adequate, attacking the alternative method used by the Minister or
showing that another method would produce a more accurate picture of its net
tax. Centrepoint cannot prove that its records were adequate. The simple fact
is that Centrepoint did not maintain the point of sale records that would have
allowed Mr. Melka to determine how GST was calculated on each sale. Therefore
Centrepoint must either attack the alternative method used by the Minister or
show that another method produces a more accurate picture of its net tax.
[20]
Centrepoint criticized the Cup Analysis. These
criticisms are irrelevant. The Cup Analysis was not the alternative method used
by the Minister to assess Centrepoint. That alternative method is described
below. The Cup Analysis was merely a rough analysis designed to show Mr. Melka
whether he should conduct a more accurate analysis using a different method. Centrepoint
gains nothing from challenging it.
[21]
The alternative method chosen by Mr. Melka was
to look at the rate of GST collected by three other Saint Cinnamon franchises. I
will refer to this method as the “Comparison Analysis”. It is the Comparison
Analysis that Centrepoint needs to attack in order to succeed on its appeal. Mr.
Melka gathered GST and supply information from the GST returns filed by these other
Saint Cinnamon franchises. He totalled the GST collected by all three
franchises. He also totalled the supplies made by all three franchises. He then
divided the total GST by the total supplies in order to determine, on average,
what percentage the GST collected by the franchises represented of their
supplies (the “Average GST Collection Percentage”). He conducted the same
analysis on a franchise-by-franchise basis in order to determine the individual
GST Collection Percentage for each franchise and did the same thing for
Centrepoint in order to determine Centrepoint’s GST Collection Percentage. He
repeated this analysis for each of the reporting periods in question. Mr. Melka
then multiplied the Average GST Collection Percentage for each reporting period
by Centrepoint’s supplies for that reporting period in order to determine the
GST that Centrepoint would have collected had it been collecting GST in line
with the Average GST Collection Percentage. Mr. Melka deducted the resulting
figure from the GST that Centrepoint actually collected in each reporting
period and the Minister assessed Centrepoint for the resulting shortfall.
[22]
The Average GST Collection Percentage in each
reporting period was approximately two to three times Centrepoint’s GST
Collection Percentage for the same period. The following chart shows the range
of percentages:
|
Year
|
Franchise #1 GST Collection Percentage
|
Franchise #2 GST Collection Percentage
|
Franchise #3 GST Collection Percentage
|
Average
GST Collection Percentage
|
Centrepoint’s GST Collection Percentage
|
|
2005
|
6.20%
|
6.27%
|
5.52%
|
6.08%
|
2.06%
|
|
2006
|
5.72%
|
5.86%
|
4.75%
|
5.62%
|
2.07%
|
|
2007
|
5.36%
|
5.43%
|
5.17%
|
5.37%
|
2.70%
|
|
2008
|
4.47%
|
4.42%
|
4.65%
|
4.47%
|
1.74%
|
[23]
Centrepoint attacked the Comparison Analysis. Centrepoint
questioned whether the comparison franchises were fair comparisons. Mr. Melka
testified that, in conducting the Comparison Analysis, he selected three Saint
Cinnamon franchises to ensure that, as near as possible, he was dealing with
the same product mix as Centrepoint’s franchise. He selected franchises from
three different cities. Each franchise had a different population base to draw
from and different levels of sales. Mr. Melka testified that he only reviewed
the data of these three franchises so I am satisfied that the comparison
franchises were not cherry picked to support the Minister’s position. I accept
that the comparison franchises may have had a different product mix available
for purchase than Centrepoint or may have made a different mix of taxable and
zero rated supplies. However, when I look at the tight range of GST Collection
Percentages for each of the comparison franchises, it is clear that there was
very little variation among them. The difference was between them and
Centrepoint.
[24]
For Centrepoint to succeed in arguing that the
comparison franchises were not fair comparisons, it would have to show that its
operations were vastly different from those of each of the comparison
franchises. It failed to do so. The simple reality is that Saint Cinnamon
franchises primarily sell coffee and cinnamon buns. While the sales of some
franchises may lean more to coffee and the sales of other franchises may lean
more to cinnamon buns, this would not make any difference because both of these
products are taxable supplies. While some franchises may sell more tea or hot
chocolate and less coffee and others may sell more scones and fewer cinnamon
buns, again none of this would make any difference as all of these products are
taxable supplies.
[25]
Centrepoint pointed out that there is no way of
telling from the GST returns of the franchises in question whether the supplies
figures used by Mr. Melka included exempt or zero rated supplies from one or
more other businesses operated by those franchises. This argument actually
undermines Centrepoint’s position. If the comparison franchises had included
exempt or zero rated supplies from other businesses in their GST returns, I
would have expected the GST Collection Percentage for those franchises to be a
lower figure than Centrepoint’s GST Collection Percentage not a higher figure.
To have succeeded on this argument, instead of arguing that the comparison
franchises may have made significant exempt or zero rated supplies, Centrepoint
would have had to argue that it made significantly more exempt or zero rated
supplies that the comparison franchises. Centrepoint did not introduce any
evidence that would support that position. There was no indication that it
operated a separate business making zero rated or exempt supplies. There was no
evidence that Centrepoint made any exempt supplies in its Saint Cinnamon
business. The primary type of zero rated supplies in a Saint Cinnamon franchise
would be sales of six or more cinnamon buns or comparable products (Excise
Tax Act, Part VI, Schedule III, section 1(m)). Lesley Beauchamp, a former
Centrepoint employee who had worked as a cashier in the relevant time period,
testified that sales of boxes of six or more cinnamon buns did not make up a
significant portion of Centrepoint’s sales. She explained that cinnamon buns
were most commonly sold as single buns and that, outside of the holiday season,
in a typical evening shift Centrepoint would only sell one or two packages of
cinnamon buns (a package being containing either 4, 6 or 12 buns). Based on Ms. Beauchamp’s
evidence, I conclude that Centrepoint did not have significant zero rated
supplies.
[26]
The better way for Centrepoint to attack the Comparison
Analysis would have been to suggest that the comparison franchises may have
made taxable supplies in other businesses that they operated and that those
additional taxable supplies would have made it appear that these franchises had
a higher GST Collection Percentage. While I appreciate that there is a risk
that this occurred, given the narrow band of percentages of GST collected
across the three comparison franchises, I think that it is unlikely. For it to
have occurred, each of the three franchises would have had to make taxable
supplies outside of their franchise operations that represented a similar
percentage of their overall sales.
[27]
Based on all of the above, I conclude that Mr.
Melka selected a reasonable set of comparison franchises.
[28]
Centrepoint also argued the Mr. Melka made no
attempt to verify that the amounts reported on the GST returns of the
comparison franchises were accurate. I do not think that this lack of
verification causes a realistic risk that the Comparison Analysis was
inaccurate. The Comparison Analysis uses the amount of supplies made by these
franchises and the amount of GST that they collected. It seems unlikely that
the franchises would have overstated either of those amounts on their GST returns
since taxpayers do not tend to intentionally cause themselves to remit more tax
than they are required to remit. If anything, the risk is that the comparison
franchises understated these amounts. Thus, it seems to me that any risk that
Mr. Melka relied on inaccurate data would be a risk to the Minister, not
Centrepoint.
[29]
Centrepoint provided its own alternative method
of determining the amount of GST that it should have collected. Centrepoint
served cinnamon buns and comparable products such as scones on disposable plates
when they were consumed in-store and in boxes when they were taken away by the
customer. There was a range of sizes and types of both boxes and plates.
Centrepoint totalled all of the plates and boxes that it purchased from February
1, 2005 to January 31, 2006. It then determined the average price at which a
cinnamon bun or comparable product would have sold for each particular type of
plate or box. It then multiplied the average prices by the number of plates or
boxes purchased. Finally, Centrepoint totalled the resulting figures to arrive
at an estimate of the total sales of cinnamon buns and comparable products that
it made in the period. Working on the apparent assumption that all sales of
cinnamon buns and comparable products were zero rated, Centrepoint then deducted
the total cinnamon bun and comparable product sales from its total sales and
applied GST to the difference. My understanding is that the result was that
Centrepoint’s GST collected in the sample period using this alternative method
was only a couple of thousand dollars higher than the GST that Centrepoint
actually collected.
I will refer to this method of calculating GST as the “Plate & Box
Analysis”. My understanding is that the purpose of the Plate & Box Analysis
was to demonstrate that the GST that Centrepoint actually collected was
accurate.
[30]
The Plate & Box Analysis is not an
acceptable alternative to the Comparison Analysis. It was only performed for 12
months out of the 54 months in issue. I have no idea what the analysis would
have shown had it been done for the remaining months. More importantly, it appears
to make the sweeping assumption that all sales of cinnamon buns and comparable
products were zero rated supplies. As discussed above, Part VI, Schedule III,
section 1(m) would make supplies of six or more such products zero rated. From
what I can tell from the descriptions of the plates and boxes purchased in the
analyzed period, almost 90% of the sales would have been of fewer than six products.
Thus, it makes no sense to use an alternative method of determining GST which
excludes all sales of cinnamon buns and comparable products. In fact, the
analysis undermines Centrepoint’s position by showing that, even if I were to
make the unrealistic assumption that all sales of cinnamon buns and comparable
products were zero rated, Centrepoint would still not have collected enough
GST.
[31]
Mr. Stathopolous provided a wildly improbably
explanation of why he believed that sales of cinnamon buns in Saint Cinnamon
franchises were zero rated. He testified that the Saint Cinnamon franchisor
told him when he bought the franchise that the CRA had provided the franchisor with
a special exemption from section 1(m) due to the fact that its cinnamon buns
were so large and heavy that the purchase of four buns was equivalent to the
purchase of six equivalent products. Mr. Stathopolous stated that he did not
have a copy of the document by which the franchisor communicated this
information to him. He was unable to direct me to anything in the legislation
granting such an exception or to anything in Part VI, Schedule III that would
allow the Minister to create exemptions to that Schedule by regulation. He
provided no details on what the magic weight and size parameters were that qualified
a product for exemption or why, for example, the sale of a single large cake or
four Tim Horton’s long Johns would not be exempt but the sale of four Saint
Cinnamon cinnamon buns would be. He also provided no explanation of why he
thought the exemption would apply to the following, all of which it appears
were included in the Plate & Box Analysis: sales of fewer than four
cinnamon buns; sales of smaller, lighter non-cinnamon bun products such as
scones; and sales of mini cinnamon buns in quantities of fewer than six. If
such an exemption existed or was incorrectly communicated to franchisees by the
franchisor, presumably the other Saint Cinnamon franchises would have taken
advantage of it as well and the resulting lower rate of GST collection would
have been reflected across all of the comparison franchises in the Comparison
Analysis. That was clearly not the case. Based on the foregoing, not only do I
find that the Plate & Box Analysis is not an acceptable alternative to the Comparison
Analysis, but I also find that Mr. Stathopolous was not a credible witness.
[32]
Based on all of the foregoing, I find that
Centrepoint has failed to demonstrate that its records were sufficiently
adequate that an alternative method of assessment was not necessary, that the
alternative method of assessment selected by the Minister was flawed or that
the alternative method proposed by it would result in a more accurate
assessment. Accordingly, I will not be adjusting the addition to net tax
assessed by the Minister on account of GST that was not collected on taxable
supplies.
[33]
Having accepted the addition to net tax
determined by the Minister, I must now consider whether it was appropriate to
apply gross negligence penalties to that adjustment. I conclude that it was.
[34]
The additional net tax payable as a result of
this adjustment was $46,418. This is 152% of the GST that Centrepoint reported
as having collected on its sales.
[35]
Mr. Melka concluded that the problem with the
GST collection arose from the point of sale systems not being programmed correctly.
The fact that Centrepoint’s GST Collection Percentage was so much lower than
the Average GST Collection Percentage indicates to me that it was only
Centrepoint’s point of sale systems that were programmed differently, not those
of all franchisees. Mr. Stathopolous testified that the point of sale
systems were programmed by the franchisor and that he did not alter that
programming in any way. He submitted that any error that was made in the
programming must have been made by the franchisor. Since I do not find Mr.
Stathopolous to be credible, I do not accept his explanation. I therefore
conclude that it was Centrepoint, not the franchisor, who changed the
programming on its point of sale systems. The question that remains is whether
Centrepoint was grossly negligent in making that change.
[36]
Despite the fact that under-collecting GST did
not put money directly into Centrepoint’s pockets, Centrepoint nonetheless had
a financial motive to reprogram its point of sale systems. Early in the periods
in question, a Tim Horton’s franchise opened in the same mall where Centrepoint’s
franchise was located. Ms. Beauchamp testified that there a noticeable drop in
Centrepoint’s sales when this occurred. Removing GST from certain sales would
have allowed Centrepoint to compete on price with Tim Hortons more effectively which
would, in turn, have allowed Centrepoint to reduce the decline in its sales.
This financial motive for reprogramming the point of sale systems leads me to
conclude that Centrepoint knowingly changed the programming with the intention
of reducing the GST it collected.
[37]
Based on all of the foregoing, I find that the
gross negligence penalties on the unreported taxable supplies should be upheld.
Conclusion
[38]
Based on all of the foregoing:
a)
Centrepoint’s income tax appeal is allowed and
the matter referred back to the Minister for reconsideration and reassessment
on the basis that Centrepoint was not grossly negligent in respect of the
disallowed expenses;
b)
Mr. Stathopolous’ appeal is allowed and the
matter referred back to the Minister for reconsideration and reassessment on
the basis that Mr. Stathopolous was not grossly negligent in respect of
the shareholder benefits he received; and
c)
Centrepoint’s GST appeal is allowed and the
matter referred back to the Minister for reconsideration and reassessment on
the basis that Centrepoint was not grossly negligent in respect of the input
tax credits that it claimed on the disallowed expenses.
Signed
at Ottawa, Canada this 25th day of November, 2015.
“David Graham”
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