Robert Kondrat v. Her Majesty the Queen, [1995] 1 CTC 2630, 96 DTC 1566

Rip J.T .C.C.:-Robert Kondrat has appealed his notice of reassessment for 1985 claiming that (a) $73,500 paid by Karon Resources Inc. ("Karon”), a company of which he was the sole shareholder at the time, to Linda Kondrat, his spouse at the time, to settle an action taken by her against the appellant under the Matrimonial Property Act of Alberta, R.S.A. 1980, c. M-9 was not a benefit conferred on the appellant that is to be included in his income pursuant to paragraph 15(l)(c) of the federal Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.), and (b) he did not knowingly or under circumstances amounting to gross negligence in the carrying out of any duty under the Act make a false statement or omission in failing to report income of $150,000 in his tax return for 1985 and thus is not liable to any penalty pursuant to subsection 163(2). The two issues are unrelated.

Benefit issue

Kondrat obtained a teacher’s certificate in computer science and then worked for a computer company in Toronto and Minnesota. He returned to Alberta in 1978 or 1979 to work in the computer division of a security company. Shortly thereafter Kondrat started a wholesale paper distributorship in Red Deer. The business was not successful and in 1983 Kondrat made an assignment in bankruptcy. He was discharged in 1984.

I am not clear when Kondrat’s business closed. He testified that in 1981 he moved from Red Deer to Calgary where he obtained employment with a seismic contractor supervising crews. He then decided to go on his own to develop seismic programs "from the ground up”. His goal was to find partners among junior oil and gas companies and to this end he incorporated Karon.

Kondrat separated from his wife, Linda Kondrat in 1978 or 1979 when living in Red Deer. "I gave her every thing...any thing I had in my possession...[except] my personal clothing." In 1984 Mrs. Kondrat petitioned for divorce and claimed custody of their five children and maintenance for herself and the children. Kondrat described the separation and divorce as "rough".

Karon was incorporated under the laws of Alberta on October 26, 1983. Kondrat was the company’s president and director. Karon carried on the business of producing and selling seismic data in the oil and gas industry. The company acquires land rights from the provinces (Alberta and Saskatchewan) to explore for oil and gas deposits by seismic means. Karon does not operate by itself. It syndicates seismic programs and drilling ventures. Where it grants others the right to use the data for drilling and exploration, Karon participates in any discovery.

In 1984 Karon started in business and had only one seismic program in that year. The economy was poor in 1985 and Karon was in financial difficulty, said Kondrat. He described the business as "speculative" and repeated that Karon was not doing well. Kondrat testified it was "hard to find players in the oil and gas business". However by the end of 1985, Kondrat had put two projects together and was working on others. Karon’s staff had increased from one to five or six people over the year.

Karon retained a geologist, Ted Hamilton, to map the seismic data. Hamilton carried on his business through TBR Resources Ltd. ("TBR"). Hamilton’s services were very important to Karon, according to Kondrat. Karon’s future successes depended on Hamilton’s presence. In 1985 he and Hamilton negotiated a "merger" of their two companies. They eventually agreed Hamilton would transfer all of his shares in TBR to Karon in exchange for shares in Karon equal to 50 per cent of all of the issued and outstanding shares of that corporation. TBR would become a wholly- owned subsidiary of Karon.

On or about April 29, 1985 Mrs. Kondrat served the appellant with a statement of claim pursuant to the Matrimonial Property Act of Alberta. She claimed an equal distribution of all the matrimonial property held by herself and Kondrat. Kondrat contested the claim on the basis that he acquired his property after the separation and his assignment in bankruptcy. In his opinion Mrs. Kondrat had not contributed to the property and was not entitled to any distribution of such property. As far as Kondrat was concerned, the Karon shares were not marital assets.

David Pilkington, a chartered accountant and partner of Hudson & Company, Karon’s accountants, prepared a letter for Kondrat’s solicitor suggesting the shares of Karon in June 1985 "would be worth a value anywhere from $0 indicating the seismic data was worthless and the future earnings potential of the company is not very favourable to a value far exceeding the cost of the seismic data indicating that the seismic data is extremely valuable".

The action under the Matrimonial Property Act proceeded through 1985 and, according to Kondrat, dates were fixed for discoveries of the parties. Mrs. Kondrat’s solicitor was aware of Karon’s existence. Kondrat’s lawyer in Red Deer had discussed with Kondrat the possibility of his shares in Karon being part of his spouse’s claim and recommended Karon’s lawyer represent him. In the autumn of 1985 Kondrat engaged the services of Karon’s solicitor, Brian Clark. The issues between the Kondrats had been settled by then except "how much money [Mrs. Kondrat] was to get from the company”, according to Kondrat.

Kondrat testified he feared that if his spouse was not satisfied with his value of Karon she would insist on an independent valuation and "could come in and expose the confidentiality of companies we were working [with] and Karon would be in jeopardy....” He did not want third parties verifying Karon’s data. Kondrat explained that in the oil and gas industry "where a company has a joint venture, you have a one-two year period of confidentiality...[and]...can’t show information to anyone else...." Karon’s right to participate would be prejudiced. "We would be removed from the program with a possible law suit.... New engineers would see what we’re doing.... We could not control this.... [It would] jeopardize us in the future.... [We] would lose credibility...."

At the time the action with Mrs. Kondrat was taking its course, Kondrat was negotiating the transaction with Hamilton. Kondrat did not want to jeopardize the "merger" with TBR which, in his view, was vital to Karon’s future. On September 30, 1985 Clark received a draft agreement between Karon and TBR from TBR’s solicitors.

In early October it appears the lawyers for Mr. Kondrat and Mrs. Kondrat had agreed on terms of settlement of the litigation. The solicitors had a telephone conversation on October 4 and then wrote each other confirming their discussions. Clark’s instructions were to settle the action if his client were given reasonable access to the children. Kondrat also agreed "in full satisfaction of your client’s claim under the Matrimonial Property Act, and costs...[to] purchase a house for a purchase price not exceeding $70,000".

Minutes of settlement were executed in early to mid-November 1985. [The dates on the copy produced as Exhibit A-13 are not legible.]

Kondrat’s access to the children and monthly maintenance payments for them are set out in the minutes. Subparagraphs 4(b), 4(c), 7(d) and 9(a) read as follows:

4(b) The wife expressly acknowledges that the money paid by the husband to or for the wife, in respect of the purchase of those lands and premises municipally described as 28 McKinnon Crescent, Red Deer, Alberta, which is in the approximate amount of $73,500, is, in part, for the satisfaction of the wife’s maintenance claims, and the husband’s agreement to pay this amount was obtained, inter alia, by the wife’s agreement not to seek maintenance at this time.

(c) The wife expressly acknowledges and agrees that the husband’s pay- ment of $73,500 as aforesaid for the purchase of the lands and premises as aforesaid, and maintenance in the amount of $150 per month, per child, is entirely sufficient for the wife to adequately provide for herself and the said children at this time.

7(d) The husband and wife specifically covenant and agree that Part I of the Matrimonial Property Act of Alberta, shall not apply to the shares and other interests held, or to be held in the future, by the husband in the business known as Karon Resources Inc., as the intention of the parties is to have section 37 of that Act apply with respect to those shares and other interests, and the wife does hereby waive and release any and all rights and claims of every kind, nature and description that she might have otherwise had as a spouse or surviving spouse in the shares and other interests now held or to be held by the husband in Karon Resources Inc., and the wife acknowledges that she is not entitled to encumber the assets of the said company or the shares thereof in any way with the registration of a certificate of Lis Pendens pursuant to the Matrimonial Property Act, or otherwise.

9(a) The parties agree that in full and complete satisfaction of any and all claims of the wife under the Matrimonial Property Act, and in further consideration of the wife not making a claim for maintenance for herself at the present time, the husband, shall pay to or on behalf of, the wife, the approximate sum of $73,500 (subject to normal real estate adjustments) representing the "deposit" and the "cash to close" required for the purchase of those lands and premises municipally described as 28 McKinnon Crescent, Red Deer, Alberta, pursuant to the terms of the offer to purchase executed by the husband for the wife, a copy of which is attached as Schedule "A" hereto;

By cheque dated November 14, 1985 Karon paid to Brian Clark Professional Corporation the amount of $73,500. The law firm apparently drew a cheque in the same amount from its account payable to Mrs. Kondrat’s solicitor.

Karon claimed the $73,500 were professional fees and deducted that amount in computing its income for 1986 pursuant to paragraph 18(1)(a) of the Act. When the Minister of National Revenue ("Minister") assessed Karon disallowing the deduction, Karon appealed to this Court. In his reasons for judgment Bonner J.T.C.C. dismissed the appeal (Karon Resources Inc. v. The Queen, [1994] 1 C.T.C. 307, 71 F.T.R. 232). My colleague Judge Bonner stated:

the $73,500 payment made by the appellant secured for its principal shareholder a release by his spouse of all her claims against him. The securing of that release was clearly the purpose for which the payment was made and that purpose, in my view, does not meet the paragraph 18(1 )(a) test.

As in Karon’s appeal, Kondrat’s position in the appeal at bar was that Karon paid the $73,500 to his spouse because of the fear the discovery process would cause confidential information to be disclosed by Karon affecting its interests. In Kondrat’s view, Karon was "in jeopardy of being exposed and the amalgamation was in jeopardy”. He stated he, himself, never offered to make payment to Mrs. Kondrat.

Kondrat explained that by October 1985 Karon had completed its first program and had found a new pool in Saskatchewan. Seven to eight more oil and gas programs were ready but required the merger with TBR. If the share transfer between Karon and Hamilton did not take place, Kondrat insisted, Karon would have no revenue base and "TBR probably would’ve taken on the programs itself.... Hamilton had offers from other companies....” Kondrat said he thought it would take up to two years to go to trial with his spouse and neither he nor Karon could wait. He had to start the program in Saskatchewan in January 1986.

Meanwhile Kondrat considered his wife to be uncooperative and thought that "if Karon could pay her something she’d release against Karon”. Kondrat acknowledged his spouse had no action against Karon "but I was a shareholder". He also admitted his spouse’s solicitor had not requested an independent valuation of Karon.

Kondrat recalled that "within Karon we decided Karon would make a proposal to release Karon Resources and to get a release of marital property claims.... [There was] no other marital property in issue..." except the shares of Karon. In Kondrat’s view, the purpose of Karon making payment to Mrs. Kondrat was to permit Karon to merge with TBR and continue to carry on the projects. The payment "was [an] enduring benefit to the company...or else [it] would’ve lost joint venture partners and probably no longer [be] in business".

Pilkington testified he discussed the entry of the $73,500 payment as a professional expense with Kondrat and advised him what form the payment could take. He said he gave Kondrat "options" and they decided to claim the payment as an expense in 1986. Pilkington declared that compared to the previous year the $73,500 would make the entry for professional fees "abnormally large" and would be "difficult to hide”.

The appellant’s counsel stated that at the time of separation his client gave Mrs. Kondrat all the property he possessed and then went bankrupt. Kondrat started Karon with assets he acquired after these two events. In the latter part of 1985 Karon began to show promise and was negotiating a merger with TBR that would be to the everlasting advantage of Karon. Also, Kondrat was putting together bids on lands. Once Mrs. Kondrat took action against him under the Matrimonial Property Act, he complained, he was unable to dispose of his property; if he did transfer property, the transferee would be liable under the Alberta statute. Mrs. Kondrat was also entitled to injunctive relief. Karon could not proceed with the merger with TBR.

In addition there was the question of confidentiality by Karon with respect to seismic data. Kondrat feared the discovery process might result in an independent inspection of the seismic data and a valuation of Karon.

Kondrat’s counsel admitted Mrs. Kondrat had taken no action against Karon "but", he said, "you don’t want to deal with problems, [you] try to avoid problems...." Counsel added that Kondrat could have proceeded to litigation but Karon was in jeopardy. Counsel declared his client had a good defence to his spouse’s action and there was no benefit to him to settle independent of the company. Mrs. Kondrat had no valid claim against the appellant, he insisted.

Karon, counsel argued, had "independent interests to ensure the integrity or confidentiality of seismic records...." Once Kondrat was released, the company could work out a deal with Hamilton. He stated certain documents produced at this trial were not before Bonner J.T.C.C. and these documents support his client’s position. These documents are included as Exhibits A-8, A-9, A-l 1 and "maybe" A-l 1.

Counsel stated that even if Mrs. Kondrat had a claim, which he denied, her interest was in Karon. This would be sufficient to prevent the transaction with TBR. He said "her rights to stop the transfers of property [were] not dependent on the outcome of the case". The interest of the company depended on the claim. "The company had an interest in putting an end to the litigation in the fall to let the transaction with Hamilton go forth."

Appellant’s counsel referred to various statutory provisions and rules of the Alberta Supreme Court to illustrate how Karon may be affected by the action between the Kondrats: section 95 of the Business Corporations Act of Alberta, S.A. 1981 c. B-15, Rules 186(2) and 191. Section 95 of the Business Corporations Act provides for an appointment of a receiver; counsel stated a receiver may be appointed in an action under the Matrimonial Property Act. He also stated "a 100 per cent shareholder and director is in control of [corporate] documents" and therefore may be discovered on such documents; also, Mrs. Kondrat had the right to inspect documents of Karon.

Finally counsel argued that Karon was the primary beneficiary of the settlement of the action with Mrs. Kondrat. By virtue of paragraph 7(d) of the minutes of settlement, Mrs. Kondrat released Karon of all rights she may have had against the corporation. Any benefit to the appellant was incidental and therefore he did not receive a benefit contemplated by paragraph 15(1)(c) of the Act.

Analysis

I cannot agree with Mr. Clark that his client received no taxable benefit when Karon paid $73,500 to terminate the litigation.

Mrs. Kondrat sued Kondrat under the Matrimonial Property Act claiming, among other things, a distribution of marital property. Only Mr. and Mrs. Kondrat were parties to the litigation. The litigation was settled on the basis that Kondrat pay Mrs. Kondrat $73,500 for the purchase of a home, she have custody of the children and she does not seek maintenance for herself.

There is no evidence that the payment of $73,500 was made for the benefit of Karon. The testimony of the appellant’s witnesses on this issue was speculative, if not hypothetical. The tenor of their evidence is found in the pleadings. In his notice of appeal, the appellant alleged:

The divorce and matrimonial property action were acrimonious and Linda Mae Kondrat’s intention with respect to matrimonial property were primarily directed to the value of the Karon shares held by Kondrat. Mrs. Kondrat was unsatisfied with the information as to the value of Karon’s shares provided by Karon’s accountant. She wished to have performed an independent assessment of the assets of Karon in order to ascertain, to her satisfaction, a value for these shares. The primary assets of Karon were confidential seismic data, acquired alone or in ventures undertaken in concert with other individuals and companies. This data collected by Karon was sold from time to time and its value was dependent in part on its confidential nature. It was intended by Mrs. Kondrat that this data would be assessed and valuated by an independent geophysical firm, with other information and data assessed by independent accountants chosen by Mrs. Kondrat or appointed by the Court. It was communicated that in the absence of voluntary production of the data a court order would be sought from the Court of Queen’s Bench of Alberta to force production of it. Karon was concerned that the dissemination of the seismic data would effectively destroy its value and marketability as a disclosure of its business dealings would expose the confidential business relationships had with its partners and co-venturers which it believed would lead to the termination, or non-consummation, of several business relationships.

Mrs. Kondrat did not testify. I do not believe Mrs. Kondrat’s intention with respect to the matrimonial property was primarily directed to the value of the Karon shares. There is not a scintilla of evidence Mrs. Kondrat was dissatisfied with the information as to the value of Karon’s shares provided by Pilkington. There is not even a suggestion she wished an independent assessment of the assets of Karon. There is no evidence Mrs. Kondrat intended to have the seismic data assessed and valued by an independent geophysical firm and independent accountants. Nobody testified that there was any communication to the appellant, or who made such communication, that, as pleaded, in the absence of voluntary production of the data a court order would be sought from the Alberta Court of Queen’s Bench to force production of it. This was not only not proven but was not even attempted to be adduced in proof. I cannot and do not accept these allegations as evidence of Karon’s fears and apprehensions. I am not satisfied that Karon was very concerned with the release to Mrs. Kondrat of the seismic data; the issue was never raised by Mrs. Kondrat’s solicitor.

Exhibit A-8, a letter dated June 4, 1985, from Pilkington to Kondrat’s solicitor in Red Deer, sets out Pilkington’s estimate of value of Karon. Exhibit A-9 is a covering letter, dated September 27, 1985, by Kondrat’s Red Deer solicitor transferring his file to Clark and advising Clark the "statement of assets under the Matrimonial Property Act has not yet been filed as the determination of value of the shares in Karon Resources Inc. has been impossible". Exhibit A-10 is a covering letter, dated September 30, 1985, from TBR solicitor to Clark enclosing a draft agreement between TBR and Karon. Finally, Exhibit A-11 is a letter to Clark from Mrs. Kondrat’s solicitor confirming the telephone conversation of October 3, 1985 with Clark. If Bonner J.T.C.C. had any or all these documents before him in the Karon appeal his judgment, in my view, would not have been different. These documents do not contribute any weight to the appellant’s position that the main beneficiary of the payment was Karon.

Kondrat and Pilkington have put the worst possible spin on what could have happened to Karon on the occasion of the action by Mrs. Kondrat. This spin is spread through the appellant’s pleadings; purported views, attitudes and actions of Mrs. Kondrat to support the appellant’s position are found in the pleadings but neither she, her solicitor nor Kondrat’s solicitor in Red Deer was called as a witness to support such allegations. At the end of the day it was Karon who paid money to Mrs. Kondrat and it was Kondrat who has benefitted. The minutes of settlement are clear on this point. Kondrat was no longer a defendant in a law suit with his wife.

The rights Mrs. Kondrat sought in her action against Kondrat are rights born of their marriage. The corporation is not a party to the action. It is not unusual for an action in law against a majority shareholder of a corporation to indirectly affect the corporation. However, the corporation in the appeal at bar, for example, has no obligation to the plaintiff spouse and any payment by the corporation to the plaintiff is a payment made for the benefit of the spouse who is its shareholder. In such circumstances the corporation confers a benefit on its shareholder: Broitman et al. v. M.N.R., [1986] 2 C.T.C. 2283, 86 D.T.C. 1711 (T.C.C.); The Queen v. Burnco Industries Ltd. et al., [1984] C.T.C. 337, 84 D.T.C. 6348 (F.C.A.); M.N.R. v. Bisson, [1972] C.T.C. 446, 72 D.T.C. 6374.

Penalty issue

The burden of establishing the facts justifying the assessment of the penalty under subsection 163(2) is on the Minister. Minister’s counsel led evidence by cross-examining Kondrat and Pilkington.

Kondrat explained Karon did not pay him a salary. Instead, in 1985, Kondrat made monthly draws from the company; at the end of its fiscal year, October 31, Karon was to pay him a bonus based on the year’s financial results. The drawings were reflected on his loan account with Karon. Kondrat stated he believed Pilkington "came up with the idea that he be paid out of the shareholder’s loan account". He also withdrew in 1985 additional amounts of $100,000, $20,000, $50,00, $60,000 and $100,000. Kondrat invested some of these amounts for Karon, including guaranteed investment certificates registered in his name. Before October 1 he had repaid $66,000.

Kondrat also stated that salary was frequently allocated to his personal participation in acquisition programs. From time to time, he would sell his interest in a property to Karon. These transactions were reflected in his shareholder’s loan account. Indeed, all transactions between Kondrat and Karon, appellant insisted, were to be processed through his shareholder’s account.

Before September 1985 Karon prepared its accounts manually. In September, after Kondrat researched various programs on the market, Karon purchased a computer and an oil and gas accounting software program. Kondrat declared that neither he nor Karon’s bookkeeper was competent in oil and gas accounting. The software company provided a person, referred to as Sylvia, Kondrat stated, to train staff and set up the oil and gas properties in the computer system but after about one and a half years he concluded "she knew nothing about oil and gas activity". The company also retained another person, Joanne, who had worked previously for a chartered accountancy firm; she was in charge of the day to day accounting.

The time between the first use of the software program in 1985 and December 1986, when the program finally worked, was "frustrating," Kondrat recalled. "The computer was not doing its job...not working properly...." He said he was aware in November 1985 that the system was not working well. By the end of October or November 1985 "Sylvia or the bookkeeper [were] telling me about errors in the system". Kondrat said he had staff check items manually. He obtained all of his information about the computer and its problems from Sylvia and the bookkeeper, Jean, whom he later married.

Pilkington described Jean as "being in over her head" but Kondrat never complained. He himself did not verify in October 1985 if the system was operating well. Essentially either Jean or Joanne, or both, was responsible for posting and Sylvia tried to fix the new system.

Pilkington had recommended Karon change from a manual to a computer accounting system. Kondrat said the company had a potential for growth in mid-1985. Pilkington said the company was growing and as the year progressed "the company was booming". The manual system, Kondrat complained, had given trouble ever since 1984 when the company was starting out. He said the year-end "audit" was a "big job" which required many corrections. (I note that the company’s financial statements were not audited in 1984 or 1985.) Kondrat did not seek Pilkington’s advice about what software program to purchase and he could not recall when he first informed Pilkington of the new accounting system.

Kondrat testified that in 1985, and in particular the latter part of the year, he was primarily occupied in "trying to get partners together". Seismic data exploration started in September or October 1985. He did not concern himself with administration although he "knew there were problems". Monthly financial reports contained errors and there were difficulties reconciling bank statements. He admitted that because of the errors, it was not safe in 1985 to rely on any account in the computer system. When Revenue Canada audited Karon "we pulled our records from the program" and realized the gravity of the errors.

Sometime in September or October 1985-Pilkington testified it was in September and Kondrat thought it was in October or November-Kondrat and Pilkington met to discuss Kondrat’s shareholder’s loan account and what he was going to report "and that sort of thing", according to Pilkington. Pilkington prepared income tax returns for Kondrat as well as for Karon.

Pilkington explained Kondrat provided him with the information to prepare his personal financial statements and "then we looked at the shareholder loan account to determine the amount of management fees and dividends that we get at the year-end tc be reported.... [T]here were [also] shareholder draws...we would do tax planning at the end of the year to determine the categorization of those". To prepare Kondrat’s tax return Pilkington relied on shareholder loan accounts and "any other T5s, T3s, donation slips, or whatever...[and] some other information that he provided us with, with respect to certain transactions". The latter information was requested by Pilkington and provided by Kondrat. Pilkington recalled that when he worked at Karon, he had free access to the company’s financial records.

Kondrat owed the company approximately $200,000 as at October 1985. Pilkington explained to Kondrat that the loan must be repaid before the end of the year if he wished to avoid paying tax on that amount. Pilkington stated that at the "particular time we didn’t know what the corporate taxable income was going to be. And I’d indicated that if we did have a debit balance left, we would either have to clear it out through management fees, or dividends, or a combination of the two". Kondrat testified that he was "probably advised by Pilkington" of the amount outstanding on his loan. He said he had a list printed out showing the amount of his loan and "put it back in".

By letter dated March 31, 1986, Pilkington wrote to Karon, to the attention of Kondrat, to explain “that we’d determined that we were going to have $480,000 of management fees at October 31, 1985 year- end, of which some we had to put to Bob’s shareholder account; and the rest were set up as an accrued liability...." By journal entry dated October 31, 1985 the shareholder loan account was credited in the amount of $104,000 as management fee.

Kondrat testified he relied on the company records on how much he owed Karon. He himself kept no records, except his bank pass book.

In any event, near the end of October 1985 Kondrat obviously knew he owed Karon about $200,000. By invoice dated October 24, 1985 he requested payment of $225,000 from Karon as follows:

Your account is debited for the following:

following seismic programs:

On the same day Karon issued a cheque, signed by Kondrat, in the amount of $225,000 to Kondrat. Kondrat deposited the cheque in his personal account on the same day. On October 29, 1985 he issued a personal cheque to Karon for $20,000.

Revenue Canada acknowledges Kondrat reported the disposition in 1985 of the Loverna property for $75,000 but says he did not include in income the $150,000. Kondrat’s reply was that the $150,000 was not a management fee for the five seismic programs since work had not yet been done on these projects. He declared the company "blocked all costs so we would know [the] costs...." The invoice "was really an estimate...of work to be done...." He insisted he did not consult with anyone when he prepared the so- called invoice. Kondrat said he did not refer personally to his shareholder’s account. He stated he paid attention to the shareholder’s account only at the end of the year. Kondrat testified the "girls gave me [a] number I had to pay back before the end of October...." He could not recall if he received written or verbal advice of the loan.

In cross-examination Kondrat was asked the reason he drew $225,000 from Karon on October 24, 1985. He replied "probably I had costs in the field [and] I had to be reimbursed...may be...part of money I needed to pay field people...." Counsel then asked if money was required to pay expenses, why did he put the money back into the company? Kondrat stated it was "month end for the company and you want to tidy things up". There was no evidence of any payments by Kondrat to "field people" or others.

Kondrat explained Karon had the right to charge a management fee to each joint venture and the $25,000 fee was included in the joint venture’s overhead. The invoice, he said, represented extra management services to the joint ventures. There was an understanding "I would get $25,000 per program as management fee". Later, in 1986, he and Hamilton split equally all management fees.

The tax problem, according to the appellant, arose when Karon’s bookkeeper, in posting the amount of the invoice, entered the code for accounts payable for the management fees of $25,000 for each project instead of entering the code for Kondrat’s shareholder loan account The practice at Karon, Pilkington explained, was that as an invoice comes in, a code is put on it. The code determines how the transaction is recorded. As Pilkington explained, the amount was credited to accounts payable and debited to each seismic program. What should have been done, he said, was to debit seismic programs $225,000 and credit due to shareholder $225,000. Such entries would record management fees and the purchase of the Loverna project. Then there would be a debit due to shareholder of $225,000 and a credit to cash of $225,000: this would reflect payment to Kondrat for amounts owing to Karon.

Pilkington said the error could have been a coding error. Pilkington’s impression was that Karon’s accounting staff understood that payments to Kondrat would be reflected in the shareholder loan account and not as a payable. He also explained he could not find the error when he prepared the financial statements because the $150,000 was capitalized into the seismic programs. The error would not be reflected by a review of any seismic program because "when we were doing our review procedures with the seismic program, we were given an analysis of the balances in there and with no real specifics...[and]...they appeared reasonable...."

Kondrat only occasionally invoiced Karon, Pilkington recalled. In his view "Bob was into deal making and operations" and left accounting to others.

Pilkington stated that even if he had performed an audit of Karon for 1985, there was no guarantee that he would have found the error: that would depend on what tests he performed during the audit. He knew there were errors in the system and, together with Joanne, had adjusted "numerous" journal entries, about 60, "to what they should be". Many of the errors were "inputting errors", according to Pilkington. There was a "lack of understanding of [the] transactions...." When Pilkington and Kondrat reviewed Karon’s 1985 financial statements and shareholder loans, they concluded, Pilkington testified, "the financial statements were reasonable and that we had accounted for anything accurately."

His review of Karon’s books, Pilkington testified, was "a correction of errors" and he had the impression "Kondrat relied on us to correct errors" and to categorize the transactions. In the company’s 1986 statements, Pilkington categorized the payment of the $73,500 paid for Mrs. Kondrat as "purchase of TBR-equity account”.

According to Pilkington, Kondrat had "a reasonable understanding" of the methodology in handling the various transactions for accounting purposes. Some of the transactions "were extremely complicated...Bob and I would sit down and there might be more than one way that was justifiable to account for a particular transaction, and we would go through them".

In Pilkington’s view he "would have had to have gone into the subledger and done an analysis" of the sub-ledger to find the $150,000. His firm was engaged to perform a compilation statement, the most basic statement, and such statement did not require a detailed analysis. For Kondrat to have found the $150,000, Pilkington said, he "probably would have had to go through all the transactions in the shareholder loan account plus any other transactions involving himself to just sort out what had to be reported". Pilkington believed "a relatively significant number of transactions" were in Kondrat’s loan account. A Mr. J. Gann of Revenue Canada prepared a statement of Kondrat’s loan account; Pilkington acknowledged Gann’s statement "was not materially different" from his working papers.

When preparing Kondrat’s financial statements and tax returns, Pilkington made no new review and relied on his work with Karon and information given to him by Kondrat. Pilkington declared that "[I]n preparing an individual’s personal financial statements, we rely on the individuals to provide us with all the personal tax information. If there’s a corporate client who we do the person’s individual tax returns, we can go to the file to check the shareholder loan account and see what has to be picked up for that particular year.... We looked at [Kondrat’s] shareholder loan account...."

Pilkington could not recall if he ever met with Kondrat to discuss his personal tax returns for 1985. He said he "usually" met with a client who signed the return. With respect to Kondrat, Pilkington said he "could’ve met with him on April 17", the date on the return, or he "could’ve cour- riered the return for signature".

The opening paragraph of subsection 163(2) reads as follows:

163(2) Every person who, knowingly, or under circumstances amounting to gross negligence in the carrying out of any duty or obligation imposed by or under this Act, has made or has participated in, assented to or acquiesced in the making of, a false statement or omission in a return, form, certificate, statement or answer (in this section referred to as a "return") filed or made in respect of a taxation year as required by or under this Act or a regulations, is liable to a penalty of....

Appellant’s counsel submitted there is no evidence that the omission of the $150,000 from Kondrat’s income was wilful. Kondrat was not a party to the coding error. In any event, he added, the relevant time to determine events surrounding the omission is not October 1985 but sometime in April 1986 when Kondrat’s tax returns were prepared.

Counsel recalled the rapid growth of Karon in 1985. He also referred to Kondrat’s evidence that he invested company funds in guaranteed investment certificates in his name for the company’s benefit; Kondrat also invested in seismic programs what he would sell to Karon. All these transactions were reflected in his shareholder’s loan account.

Kondrat’s counsel argued that on the facts his client was not grossly negligent to rely on corporate records or findings of the company’s accountant. The accountant thought the records were accurate and advised Kondrat the information was probably correct. Kondrat reviewed the statements with Pilkington and, counsel stated, while the content of their conversation regarding the review is not perfectly clear, the conversation was to the effect all was right. Kondrat’s information, counsel said, was that if he owed Karon money at the end of the year he had to repay any loans to avoid paying tax. He wanted to prevent the $200,000 in the shareholder’s loan account from being included in income.

The charge of $150,000 was to the joint ventures. Even if Kondrat had not sent the statement, Karon would still have charged each joint venture $25,000. Kondrat would have provided the management services and Karon would bill the program, counsel stated. Once Hamilton joined Karon, Hamilton and Kondrat shared equally all management fees despite who managed a particular project. The invoice, counsel asserted, was simply "paper" to be used for the co-venturers in the project and was not a real invoice.

Counsel acknowledged Kondrat did not pay enough attention to his shareholder’s loan account since he was busy at the time finding partners for programs.

There was no evidence, according to Clark, appellant’s counsel, that Kondrat knew in October 1985 what his income was for 1985. There is no evidence Kondrat checked the company ledger or journal entries; the only evidence is that Kondrat looked at the balance of various accounts. He cannot be faulted in relying on his shareholder loan account. He cannot be blamed for relying on the work of his accountant in satisfying himself all was correct. Kondrat relied on trained staff and an accountant to sort out and identify what transpired. If Kondrat made any error, counsel suggested, it was clear only by checking the payable ledger account and "the ledger had zeroed itself out".

Karon had accounted for the $225,000 as an account payable. Unfortunately, according to counsel, the system broke down. Nobody had informed Kondrat the data was unreliable and should be reviewed further. This does not constitute gross negligence, his counsel submitted.

Kondrat never thought he should maintain his own records. He believed there was a system in place at Karon to determine his income from the company. The accounting staff at Karon carried on work for Karon that he could use. After reviewing the records he was of the view he had "netted" all the transactions. There was no "wanton disregard" of his responsibilities under the Act.

Analysis

The meaning of the words "gross negligence" was discussed by Strayer J . in Venne v. The Queen, [1984] C.T.C. 223, 84 D.T.C. 6247 (F.C.T.D.), at 234 (D.T.C. 6256):

"Gross negligence" must be taken to involve greater neglect than simply a failure to use reasonable care. It must involve a high degree of negligence tantamount to intentional acting, an indifference as to whether the law is complied with or not. I do not find that high degree of negligence in connection with the misstatements of business income. To be sure, the plaintiff did not exercise the care of a reasonable man and, as I have noted earlier, should have at least reviewed his tax returns before signing them. A reasonable man in doing so, having regard to other information available to him, would have been led to believe that something was amiss and would have pursued the matter further with his bookkeeper.

At most, appellant’s counsel conceded, Kondrat was negligent in the carrying out of his duty under the Act. However, his negligence was not the gross negligence required by subsection 163(2). His client, he submitted, was not indifferent to whether the law was complied with or not. Karon’s computer system had not been completely set up and Pilkington, who was given free access to the company’s financial records, had to make many corrections by journal entry. Kondrat relied on records he believed were correct. He was not grossly negligent.

In Cloutier v. The Queen, [1978] C.T.C. 702, 78 D.T.C. 6485 (F.C.T.D.), at page 705 (D.T.C. 6487) Marceau J. stated:

The question before the Court is whether the circumstances under which the omission occurred are such that gross negligence may be attributed to the taxpayer: "gross negligence" being taken to mean a relatively ocrious act of negligence, which is difficult to explain and socially inadmissible. The factual circumstances in themselves do not present a problem, they are all established; it is the way in which they should be regarded which is at issue, namely, what can be deduced from them concerning the acts of plaintiff which are at issue. This is not a question of fact in the sense of a question regarding an earlier factual circumstance or an event which took place at an earlier point in time, but a question of legal appraisal and judgment on the actions, which is not subject to proof but depends on the personal conviction of the individual making the decision.

[Translation.]

The appellant’s position, simply put, is that he put in place in Karon a system to record all transactions he had with the company. There are no circumstances amounting to gross negligence if there was a foul up in the company’s accounting system resulting in his failure to report income. The appellant’s view was that since Karon maintained proper records, or ought to have maintained proper records, of his transactions there was no need for him duplicate these records. In short, the appellant’s position is that the omission of the $150,000 was not his fault.

Karon’s manual accounting system was not functioning properly before September 1985; things did not improve when it was converted to computer in September. Only in December 1986 did the system start to work properly, even though modifications were still being made in 1994. One of the employees (Jean) who performed accounting operations was wanting in the necessary skills, yet Kondrat let her continue.

Kondrat knew early on that the new computer program was not as advertised and errors were not uncommon. I have some doubt that even if the system were working to acceptable norms, if not perfection, the omission would not have occurred. Kondrat blamed the error not only on the inadequacies of the computer system but also on the error by a bookkeeper in writing the wrong code to the invoice. Leaving aside the computer problems, had Kondrat given the invoice to the same person it is not unreasonable to conclude she would probably have posted the same code.

Kondrat was not in the practice of issuing invoices to Karon. The issuance and receipt of the invoice itself was unusual and the amount of the invoice substantial. I doubt Kondrat simply handed the invoice to an employee and had a cheque prepared without specific instructions; he does not strike me as that type of person. When the member or the accounting staff received the invoice from Kondrat one may infer she asked Kondrat, or he informed her, how to treat the $225,000. It was Kondrat who prepared the cheque payable to himself, deposited it to his account and then repaid $200,000 to the company. On this occasion, he was "hands on".

Pilkington never suggested the employee erred when she credited the account payable and debited the seismic program. His evidence was that this was not what was intended, not that it was wrong. Pilkington declared that a transaction may be subject to more than one interpretation. His treatment of the $73,500 as professional fees is an example.

Kondrat was aware by October 1985 that Karon was having problems with the computer system. He knew the accounting staff was not competent yet did almost nothing to supervise the work. He did hire Joanne to help clear up the problems of an accounting program peculiar to the oil and gas industry. When he reviewed copies of accounts he only looked at the bottom line. He was busy promoting Karon’s business and I do not fault him for that. However, Kondrat was the sole shareholder of Karon and I find it strange that he had a rather cavalier attitude with respect to how the company’s accounts were maintained. Pilkington stated that there were numerous transactions in Kondrat’s loan accounts. The statement prepared by Gann shows only 21 transactions in calendar 1985, 11 of which were monthly draws. I do not believe it would have been an onerous task to have reviewed the account in April 1986. My impression of Kondrat is that he wanted to know, and knew, what was going on in his company. Pilkington was able to discuss complicated transactions with him during preparation of the financial statements. Kondrat may not have made daily inquiries with respect to the accounts but I find it difficult to find he did not keep a finger on the pulse of the company. He knew the problems with the computer program were serious. In any event the omission of the $150,000 from the appellant’s income was not a so-called computer error. It was a human error, if it was an error at all. While Karon undoubtedly had bad experiences with the computer program, both Kondrat and Pilkington have exaggerated the computer problems as a cause of the omission.

Kondrat apparently kept no personal financial records of his dealings with Karon. He said he did not keep a copy of the invoice for $225,000, not a small sum by most people’s standards. In April 1986 he did not remember sending the invoice. In 1985 Kondrat reported employment income from Karon of $134,273.60 and management fees of $98,873.12. He wrote the cheque in the amount of $225,000 to himself and then deposited the cheque in his personal bank account. Surely his personal bank records would reflect the transaction. This was in his possession when he reviewed his 1985 tax return. Kondrat did remember, when filing his 1985 tax return, to report the disposition of the Loverna property for $75,000; this amount was in the same invoice as the management fees. The facts in this appeal have nothing in common with those in Udell v M.N.R., [1969] C.T.C. 704, 70 D.T.C. 6019 (Ex. Ct.) where the gross negligence was that of the accountant.

Kondrat knew or ought to have known he invoiced a management fee to Karon and received payment. When he could not recall this transaction in April 1986, he had simply put it out of his mind. The omission by the appellant to report the $150,000 in his income for 1985 is a circumstance amounting to gross negligence in the carrying out of a duty or obligation under the Act.

The appeal is dismissed with costs.

Appeal dismissed.