REASONS
FOR JUDGMENT
Hogan J.
I. Overview
[1]
The issue in this appeal is whether the
Appellant, Mr. Brian David Cherniak (“Mr. Cherniak”), was properly assessed by
an assessment (the “Assessment”) under subsection 323(1) of the Excise Tax
Act (the “ETA”) in respect of the unremitted goods and services tax (“GST”)
of GMC Distribution Ltd. (“GMC”) in the circumstances described below.
[2]
The Appellant challenges the Assessment on two
grounds. First, the Appellant claims that GMC does not have any GST
liability and thus disputes the underlying assessment (the “Corporate Assessment”)
issued against it. Secondly, the Appellant argues that he acted diligently to
ensure that GMC complied with its GST collection and remittance obligations.
II. Factual Background and Credibility Findings
[3]
In July of 2006, the Minister of National
Revenue (the “Minister”) assessed the Appellant for the amount of $6,165,394.23
with respect to unremitted GST, interest and penalties owed by GMC for the
reporting periods from March 1, 1999 to September 30, 2002. The
particulars of the Assessment are set out in Appendix A to these reasons for
judgment.
[4]
On October 24, 2002, the Canada Revenue Agency
(“CRA”) registered a certificate with the Federal Court under section 316 of
the ETA with respect to the unpaid GST liability of GMC. On the same date, a
writ of seizure and sale (the “Writ”) was issued by the Federal Court to the
sheriff of the City of Toronto. The sheriff’s office was instructed in
2006 to execute the Writ. It was returned nulla bona on account of
the fact that GMC had no assets. This prompted the Minister to assess the
Appellant as noted above.
[5]
At the outset of the trial, the Respondent
conceded that the amounts shown for the first ten periods listed in Appendix A,
representing in total $8,482.71, could not be assessed against the Appellant
because these amounts were not covered by the certificate filed with the Federal
Court on October 24, 2002, as described above (the “Concession”). While
acknowledging that the appeal should be allowed to the extent of giving effect
to the Concession, the Respondent submits that the balance of the Assessment is
accurate.
[6]
The Appellant’s evidence was, for the most part,
presented by himself. He also called Mr. George Abela (“Mr. Abela”) to
describe his alleged business dealings with GMC. As elaborated upon below, the
Appellant’s and Mr. Abela’s accounts differed significantly on numerous points.
[7]
The Respondent called two CRA officers as
witnesses. I heard from Mr. Ruffolo, the CRA collection officer who issued
the Assessment against the Appellant. Mr. Yasotharan then testified concerning the
circumstances that led him to issue the underlying Corporate Assessment against
GMC.
[8]
The Appellant testified that GMC started
carrying on the business of selling new and used computer parts in bulk in 1999
(the “Computer Parts Business”). The Appellant claims he was approached with
this opportunity by a person he identified as Mr. John Nixey
(“Mr. Nixey”). The business venture was operated through GMC even though
neither Mr. Nixey nor the Appellant held an interest in GMC. According to
the Appellant, the economic arrangement with Mr. Nixey was that the latter
would receive a leased vehicle from another corporation belonging to the
Appellant. The Appellant dealt with the banks. The Appellant alleges that
Mr. Nixey handled all of the other day‑to‑day operations of the
Computer Parts Business.
[9]
According to the Appellant, GMC acted as
intermediary between Micro Computer Connections (“Micro Connections”), a sole
proprietorship belonging to Mr. Morgan Jacobs (“Mr. Jacobs”), and Brocton
Resources (collectively, the “Suppliers”), and Jag Distributors, Jay-Tek
and perhaps FB Enterprises, StarDust.com, and Computer Micro-Electronic Canada
(the “Customers”), entities controlled by Mr. Abela and/or his son. It appears
from the invoices submitted as evidence that Micro Connections supplied
substantially all of the computer parts to GMC. According to the Appellant,
Mr. Abela and his son were in the business of exporting computer parts to Malta and the United States.
[10]
As intermediary between the Suppliers and the Customers,
GMC earned a nominal gross margin of approximately 0.25%. The Appellant
calculated the sale price of the computer parts by taking into consideration
the purchase price and marking it up by approximately 0.25%. The Appellant then
applied the GST rate to that total amount.
[11]
The Appellant claims that the first large
amounts of computer parts were received in the months of July, August and
September 1999. During examination in chief, the Appellant alleged that he only
saw the parts that Mr. Nixey had left over because they were not being
shipped, or that were part of the small inventory that was kept at the time.
During cross-examination, the Appellant maintained that he had seen from
20% to 25% of all the shipments received. His evidence on this point was very
uncertain.
[12]
The Appellant caused GMC to maintain an account
at the Royal Bank of Canada (the “Royal Bank Account”) for receipts and
payments related to the Computer Parts Business. When he received computer parts,
the Appellant alleges, Mr. Jacobs instructed him to make payments to an
account at the Canadian Imperial Bank of Commerce (the “CIBC Account”) through
electronic funds transfers. The CIBC account was linked to an offshore
account at a German bank in the Bahamas. The Appellant claimed that
Mr. Nixey would fill in the amount of the payment or have the bookkeeper,
the Appellant’s mother, complete the payment instructions. The Appellant
would sign each request for payment.
[13]
The Appellant testified that the terms of
payment were cash on delivery because the Suppliers did not offer GMC any
credit terms and GMC did not have financing available to immediately pay for
its supplies. GMC would buy the parts from the Suppliers and deliver them to
the Customers on the same day. According to the Appellant, GMC’s Customers
released payment before receiving the computer parts. When the Appellant was
asked during the trial to provide further information as to how this payment
system operated, he testified that he was not sure he had accurate information on
that and that he did not remember every detail.
[14]
The evidence shows that the Royal Bank (“RBC”)
expressed concerns about the amount and the nature of the payments made out of
and the deposits made into the Royal Bank Account. RBC threatened the Appellant
with closing the account unless information concerning the operations and the financial
standing of the parties was provided. RBC eventually did close the Royal Bank
Account.
[15]
During trial, the Appellant said that, when he
met with the Suppliers in 1999, they provided him with a GST number either
verbally or by fax. The Appellant alleges that he called the CRA to
confirm whether the GST number was valid, but he was informed that the CRA
could not provide him with that information. Nevertheless, Mr. Jacobs’ invoices
for the period before August 30, 2000 submitted by the Appellant as
exhibits during trial did not indicate a GST registration number.
[16]
A number of Mr. Abela’s observations on the
circumstances surrounding his business dealings with GMC stood in stark
contradiction to the Appellant’s version of the facts. The most notable example
of their inconsistent testimony was their disagreement on how the Customers paid
for the goods supplied by GMC.
[17]
As indicated, Mr. Cherniak stated that Micro
Connections, the key supplier to GMC, required that GMC pay for the goods on or
before delivery. Mr. Cherniak acknowledged that GMC did not have a line of
credit or any funds to pay for the goods. Therefore, GMC demanded payment from
its Customers prior to delivering the computer parts to them. In contrast, Mr.
Abela insisted during his testimony that GMC’s Customers were in the same precarious
financial situation as GMC. They could not pay for goods before receiving
payment from their own customers. Mr. Abela testified that his clients paid on
delivery or in the 30‑day period following delivery. From
Mr. Abela’s testimony, it does not appear that GMC could have paid for the
goods acquired from the Suppliers prior to delivery.
[18]
In the audit report for GMC, Mr. Yasotharan
carefully documents the alleged flow of computer parts starting with Micro
Connections. His findings in that regard are illustrated in Appendix B to these
reasons. He observes that Micro Connections was not registered for GST purposes
until August 30, 2000. This explains why there was no GST number indicated on
the invoices provided to GMC. He believes that Micro Connections became a
registrant because Mr. Jacobs had learned that GMC was being audited. Mr.
Yasotharan also noted in his testimony that Micro Connections did not remit the
GST that it purportedly collected from GMC.
[19]
Mr. Yasotharan further notes that payments from
the final non-resident customers in the chain of transactions were made from an
offshore bank account located in the Bahamas. Surprisingly, payments made by
GMC to Micro Connections were also deposited in an offshore bank account with
the Ansbacher Bank. He described it as odd that a Canadian supplier of computer
equipment that allegedly purchased computer parts in Canada would deposit
Canadian dollar payments in an offshore account. He could not identify the holders
of these offshore bank accounts. GMC and the Appellant did not provide any
credible evidence in this regard. Mr. Yasotharan’s conclusion was that the
payments were simple window dressing designed to mask the fact that the
entities inserted in the chain were engaged in artificial transactions designed
to trigger large GST refunds in connection with fictitious zero-rated export
sales. He also concluded that all documentation created into by the parties was
window dressing.
[20]
As pointed out by the Respondent’s counsel in
his oral submissions, this type of arrangement is commonly known as a “carousel scheme”. Money flows in a predetermined manner
opposite to the flow of fictitious transactions. The money starts and ends with
the same parties. The GST is drawn out of the system on the basis of fictitious
export sales of zero‑rated supplies that allow the exporter‑seller
to receive large refunds in connection with tax that was never remitted in the
first instance. Numerous buyers and sellers are inserted into the transaction
flow to mask what is really going on.
[21]
Another striking contradiction relates to the
Appellant’s and Mr. Abela’s testimony on who played a key role in the
transactions. The Appellant claims that Mr. Nixey handled the day‑to‑day
operations of the computer parts business. According to the Appellant, he
himself handled only the bank transactions, which were based on invoices
received and the payment instructions prepared at the direction of
Mr. Nixey. In contrast, Mr. Abela insisted that he often dealt with
Mr. Cherniak, including when he picked up goods.
[22]
Another curious example of contradictory
evidence is Mr. Abela’s and the Appellant’s divergent testimony on the
circumstances which led them to terminate their business dealings. Mr. Cherniak
claimed that the entities controlled by Mr. Abela and his son discovered
the source of GMC’s supply and arranged with Micro Connections to eliminate GMC
as an intermediary. Mr. Abela alleges that this is not what happened.
Rather, his customers suddenly stopped placing new orders. I surmise that it
was no coincidence that the business dealings of the entities listed in
Appendix B stopped following the commencement of CRA’s audit of their
arrangements.
[23]
The following is a list of some other facts
which further serve to discredit the Appellant’s evidence.
(i) Mr. Cherniak claims that Mr. Nixey
brought him the proposal to launch the Computer Parts Business. Mr. Nixey
allegedly did all the work, came up with a plan for purchasing goods from, and
selling them to, acquaintances of his, yet he had no ownership or profit
interest in the business. According to Mr. Cherniak, 100% of the shares of
GMC belonged to his brother. Early in his testimony, the Appellant alluded to
the fact that Mr. Nixey was provided with the use of a vehicle by Amber
Technology, along with an office on its premises. The impression the Appellant
gave was that this was Mr. Nixey’s compensation for his work in the Computer
Parts Business. When the hearing resumed many months later, the Appellant
changed his story. He alleged that the vehicle and the use of an office were
provided by Amber Technology to Mr. Nixey as part of the consideration for
his purchase of shares in Amber Technology. The question left unanswered is
what was Mr. Nixey’s and the Appellant’s economic interest in the business. The
Appellant offered no reasonable explanation why he and Mr. Nixey apparently
decided not to be shareholders of the entity that carried on the business.
(ii) Mr. Cherniak claims that the computer parts
were, for all intents and purposes, commodities, yet GMC never tried to
diversify its supplier base. There is also no evidence to suggest that GMC
tried to diversify its customer base.
(iii) Mr. Abela acknowledged that he knew little
about computers and their components. When cross-examined regarding the parts
listed on the invoices prepared by Mr. Abela, he could not identify what
functions were performed by the parts or, for that matter, who manufactured them.
It was abundantly clear from the evidence that Mr. Abela did not have the
experience or skills to run a multi‑million dollar computer parts business.
Further, Mr. Cherniak knew Mr. Abela personally. He had hired him to
do some construction work on Amber Technology’s premises. It is impossible for
me to believe that Mr. Cherniak, who is an astute business person and a
Chartered Management Accountant, did not discern Mr. Abela’s shortcomings
in this regard.
(iv) The gross margin on sales made by GMC was
absurdly low. Mr. Cherniak acknowledged that GMC earned a net profit of
$60,000 on sales of approximately $54,000,000. I cannot conceive how this low
gross margin allowed GMC to absorb all of its costs.
(v) Mr. Cherniak acknowledged that RBC
expressed concerns over the financial transactions flowing through GMC’s
account. Ultimately, RBC terminated its relationship with GMC.
[24]
In light of all of the above, I conclude that
the evidence presented by the Appellant was neither reliable nor credible. The
compelling inconsistencies noted above suggest that the Appellant did not
testify truthfully. Mr. Abela’s evidence also fell well short of the mark.
As a final observation, I note that Mr. Abela acknowledged that he
declared bankruptcy soon after receiving an assessment for unremitted GST due
by the corporations for which he acted as a director. Mr. Abela claims
that he did not challenge the assessment made against him because he did not
have the financial resources to do so. From his testimony, I infer that he
likely concluded that he could not mount a successful defence. Many times, he
answered questions on cross‑examination by claiming he could not recall the
facts. The impression I was left with was that Mr. Abela was deliberately
trying to mask his complicity in a so-called carousel scheme. Likewise, the
Appellant left me with a similar impression.
III. Analysis
A. Were
the Transactions Genuine?
[25]
The Appellant challenges the Corporate
Assessment on the grounds that GMC was entitled to claim the input tax credits
(“ITCs”) that were denied by the Minister.
[26]
The evidence leads me to the conclusion that GMC
was not buying and selling computer parts. In my opinion, GMC could only pay the
Suppliers’ invoices because the parties were not preoccupied with payment and
credit risks. The payments flowed in a circular fashion, starting and ending in
offshore bank accounts likely controlled by parties who were acting in concert.
Therefore, I accept the Respondent’s theory that GMC participated with others in
what amounted to be paper transactions as part of an elaborate ruse to defraud
the government of tax revenue.
[27]
While the transactions were artificial and GMC
was barred from claiming ITCs in respect of its fictitious purchases, it was
nonetheless required to remit the GST that it charged and collected from its customers.
Section 222 of the ETA provides that every person who collects an amount “as or on account of tax” is deemed to hold the amount
in trust for the government. Such amounts are included in the definition of “net tax” under subsection 225(1) of the ETA. This triggers the requirement for the GST registrant to
remit those amounts with its GST returns. This interpretation of the law was
endorsed by the Federal Court of Appeal (the “FCA”) in 800537 Ontario
Inc. v. The Queen.
Therefore, apart from the Concession, the Assessment against GMC is accurate.
B. The
Appellant’s Due Diligence Defence
[28]
The Appellant argues that as a director of GMC
he exercised the degree of care, diligence and skill to prevent the failure to
remit that a reasonably prudent person would have exercised in comparable
circumstances. The Appellant made the dubious claim that any blame for GMC’s failure
to remit the GST belongs to Mr. Nixey.
[29]
Subsections 323(1) and 323(3) of the ETA read as
follows:
If a corporation
fails to remit an amount of net tax as required under subsection 228(2) or
(2.3) or to pay an amount as required under section 230.1 that was paid to, or
was applied to the liability of, the corporation as a net tax refund, the
directors of the corporation at the time the corporation was required to remit
or pay, as the case may be, the amount are jointly and severally, or
solidarily, liable, together with the corporation, to pay the amount and any
interest on, or penalties relating to, the amount.
. . .
A director of a
corporation is not liable for a failure under subsection (1) where the director
exercised the degree of care, diligence and skill to prevent the failure that a
reasonably prudent person would have exercised in comparable circumstances.
[30]
The FCA’s approach to the directors’
due diligence defence under subsection 323(3) of the ETA has evolved over time as
noted below. The original test, as formulated in Soper v. The Queen, was an objective-subjective
test that incorporated the common law subjective test into the statutory
provision:
. . . Rather
than treating directors as a homogeneous group of professionals whose conduct
is governed by a single, unchanging standard, that provision [subsection
227.1(3) of the Income Tax Act] 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. . . .
[31]
In March 2011 the FCA released its decision in Buckingham
v. Canada, where it held that the directors’ due diligence defence test in Soper
had been replaced “by the objective standard laid down by
the Supreme Court of Canada in Peoples Department Stores. . . .
The reference to a reasonably prudent person is a clear indication that the
test is objective rather than subjective.” Even though the decision in Peoples
Department Stores Inc. (Trustee of) v. Wise
dealt with the wording of the Canada Business Corporations Act, the
provision dealing with directors’ liability has similar wording to subsection
323(3) of the ETA. Thus, on the basis of the statutory interpretation principle
of the presumption of coherence between statutes, the FCA has interpreted the
decision in Peoples Department Stores as setting the standard for a due
diligence defence for directors’ liability under the ETA and the Income Tax
Act (the “ITA”).
[32]
In Buckingham, the FCA outlines as
follows how to apply the objective standard:
This objective
standard has set aside the common law principle that a director's management of
a corporation is to be judged according to his own personal skills, knowledge,
abilities and capacities: Peoples Department Stores, at paragraphs 59
to 62. To say that the standard is objective makes it clear that the factual
aspects of the circumstances surrounding the actions of the director are
important as opposed to the subjective motivations of the director: Peoples
Department Stores at paragraph 63. The emergence of stricter standards
puts pressure on corporations to improve the quality of board decisions through
the establishment of good corporate governance rules: Peoples Department
Stores, at paragraph 64. Stricter standards also discourage the appointment
of inactive directors chosen for show or who fail to discharge their duties as
director by leaving decisions to the active directors. Consequently, a person
who is appointed as a director must carry out the duties of that function on an
active basis and will not be allowed to defend a claim for malfeasance in the
discharge of his or her duties by relying on his or her own inaction: Kevin P.
McGuinness, Canadian Business Corporations Law, 2nd ed. (Markham,
Ontario: LexisNexis Canada, 2007) at 11.9.
[33]
This evaluation should not be undertaken,
however, without considering the particular circumstances facing the
corporation and the appellant. The FCA, in Buckingham, asserted that
contextual factors are part of an objective analysis.
[34]
The FCA in Buckingham specifically notes
that, in applying the test under subsections 227.1(3) of the ITA and 323(3) of
the ETA, one must consider a director’s actions undertaken to prevent a failure
to remit.
[35]
The Appellant contends that he should not be
required to bear the corporation’s GST liability because the corporation’s
failure to remit the GST occurred without his knowledge and was due to
circumstances beyond his control. When he discovered the failure, it was too
late for him to do anything about it.
[36]
The Appellant tried his best to place the blame
for GMC’s failure to remit the GST squarely on Mr. Nixey’s shoulders. Despite
the Appellant’s best efforts in this regard, he failed to establish that he was
an unsuspecting victim of a ruse implemented by Mr. Nixey. On the contrary, there
were many suspicious and unusual circumstances that show that the Appellant was
an active participant in the arrangement. For example, the Appellant acknowledged
that GMC’s Suppliers needed to be registered for the GST and to provide GMC
with proof of their registration in order for GMC to be able to claim ITCs on
its purchases. In spite of this, the Appellant did not take adequate steps to ensure
that the Suppliers had valid GST numbers. The evidence shows that no
registration number was shown on the invoices that GMC received from the Suppliers.
He claims that he inquired about and received a GST number from Micro Connections
when GMC commenced purchasing goods from Mr. Jacobs. However, when he was
asked by the CRA auditor to produce the number allegedly provided by Mr. Jacobs
at the outset of his dealings with GMC, the Appellant provided the auditor with
the number obtained by Mr. Jacobs only after the audit had commenced. There is
not a shred of reliable evidence to support Mr. Cherniak’s assertion that
he looked into this matter. The volume of purchases and sales was huge for a
new business. Payments were made to an offshore bank account. RBC asked
questions, yet Mr. Cherniak claims he did not have any reason to worry.
[37]
It was Mr. Cherniak’s evidence that Mr. Nixey
handled all of the day‑to‑day operations of the computer business.
His evidence was contradicted by that of Mr. Abela.
[38]
Mr. Cherniak’s description of his business
relationship with Mr. Nixey is simply unbelievable. He claims that Mr. Nixey
brought GMC the opportunity and that he worked ceaselessly to make the business
a success, yet he acknowledges that Mr. Nixey was not paid for his
services and did not have an ownership interest in GMC. He implied that Mr. Nixey
enjoyed the use of a leased truck, but this vehicle and the use of an office were
supplied by Amber Technology, a corporation controlled by Mr. Cherniak. Later in
Mr. Cherniak’s testimony, he claimed that these perks had nothing to do
with Mr. Nixey’s role in the Computer Parts Business. Mr. Nixey apparently
negotiated the perks as part of the consideration for a capital investment in
Amber Technology.
[39]
As a final observation, I note that Mr. Cherniak
did not call Mr. Nixey as a witness, although he was reminded by the Court that
he could call additional witnesses when it became apparent that the hearing
could not be completed in the time requested by the parties. He was also
informed that he could compel reluctant witnesses to appear by subpoena. In
spite of this, the Appellant chose not to call Mr. Nixey. I therefore infer
that Mr. Nixey’s testimony likely would have contradicted the evidence
presented by the Appellant.
[40]
In light of all of the above, I conclude that
there is sufficient evidence of Mr. Cherniak’s complicity in allowing GMC to
engage in non‑bona fide transactions. In summary, the evidence completely
undermines the Appellant’s due diligence defence.
[41]
Therefore, the appeal is allowed only for the
purpose of allowing the Minister to give effect to the Concession.
[42]
Costs are awarded to the Respondent.
Signed at Ottawa, Canada, this 2nd day of March 2015.
“Robert J. Hogan”
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