Paul E. Pelletier v. Minister of National Revenue, [1992] 1 CTC 2270, 92 DTC 1279

Mogan, T.C.C J.:—The appeals herein are from reassessments for the years 1980, 1981, 1982, 1983, 1984 and 1985. The issues are all questions of fact which will be determined by reference to the credibility of the appellant, the presence or absence of certain documents in evidence and the onus of proof. There is no question of law to be decided in these appeals.

When issuing reassessments for the taxation years under appeal, the respondent isolated seven separate categories for which he either added certain amounts to be included in the computation of the appellant's income or disallowed the deductions of certain amounts which the appellant had deducted in computing income. The respondent also assessed a penalty under subsection 163(2) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") for each of the years under appeal. The appellant disputes the imposition of penalties and all seven categories relating to the computation of income. The action taken by the respondent relating to the computation of income is summarized in the seven categories listed below.

CATEGORY 1. Amounts of interest received from guaranteed investment certificates registered in the names of one or more of the appellant's daughters were added to the appellant's reported income in the following years:

CATEGORY 2. Amounts of interest which the appellant alleges belonged to a trust for his mother or in his mother's name were added to the appellant's reported income in the following years:

CATEGORY 3. Amounts of rental income with respect to two properties in Edmundston, New Brunswick owned by the appellant were added to the appellant's reported income in the following years:

After the appellant filed notices of objection, the respondent issued fresh reassessments for 1983 and 1984 accepting certain expenses (but not capital cost allowance) with respect to the two properties and reducing the above rental income to the following respective amounts:

CATEGORY 4. Amounts of interest from two mortgages registered in the names of Lise Pelletier (the appellant's daughter) and Albertine Pelletier (the appellant's wife) were added to the appellant's reported income in the following years:

CATEGORY 5. Amounts of interest which the appellant alleges that he paid with respect to money borrowed to earn income from business or property were disallowed as deductions in computing the appellant's income for the following years:

CATEGORY 6. The amount of $19,337.10 which the appellant alleges that he paid as legal fees to other lawyers in connection with the appellant's law practice at Edmundston, New Brunswick, was disallowed as a deduction in computing the appellant's income for 1985.

CATEGORY 7. The appellant alleges that he incurred disbursements on behalf of clients over a period of years and that such disbursements are deductible in computing income to the extent that they were not repaid by the clients on whose behalf they were incurred. The appellant deducted $20,000 as a noncapital loss for each of the taxation years 1983 and 1984 and the respondent disallowed such deductions.

Each category is a separate issue in which the evidence must be weighed to determine whether the assessing action taken by the respondent can be sustained. I shall consider the seven categories in the above order and then review the penalties imposed by the respondent. The appellant was born in 1914 and called to the bar of New Brunswick in 1939. After serving in the armed forces during World War II, the appellant began to practise law in Edmundston in 1946 in association with a lawyer named Pichet. When Mr. Pichet was appointed a judge in 1963, the appellant thereafter practised alone until 1987 when he retired.

CATEGORY 1. The appellant does not dispute the fact that interest in the aggregate amount of $123,602.85 shown above was received in the years of 1982 to 1985 inclusive but he claims that such interest belonged to certain of his daughters and not to him. The appellants Exhibit A-1 shows that for the years 1981 to 1984 Central Trust Company had issued guaranteed investment certificates ("CICs") in the name of Monique Pelletier (appellant's daughter born in 1965) in the following principal amounts and yielding the interest indicated:

The appellant's Exhibit A-2 comprising certain T5 information slips issued by Central Trust Company and the Banque Nationale shows Monique Pelletier as having received the following amounts of interest:

The appellant testified that his daughter Monique owned the GICs in question and that they were purchased with funds gifted by him. The appellant also identified three other daughters (Pauline, Lise and Madeleine born from 1959 to 1963) as having GICs registered in their names but purchased with funds gifted by him. He stated that the income from the GICs was used in the years 1981 to 1985 to defray the cost of their attendance at colleges and universities in New Brunswick and outside the province. In summary, the appellant maintains that the GICs were owned beneficially by the daughters having been purchased with funds gifted by him; and that any interest income derived from the GICs belonged to the daughters.

The credibility of the appellant is a significant factor in deciding this first issue. His statements that the GICs were either gifted to the daughters or purchased in their names with funds that he had gifted to them are, at face value and subject to an “attribution rule” concerning the younger daughter, a complete answer to the assessing action taken by the respondent. In other words, if the GICs were owned beneficially by the daughters, then the interest income derived from the GICs should be taxed in the daughters’ hands and not in the hands of the appellant.

Considering the equivocal nature of the few documents which were put in evidence by the appellant, I would have expected him to call at least one of his daughters as a witness to corroborate the fact that she was in 1985 and prior years the beneficial owner of certain identified GICs. She might have given evidence concerning when she first learned that she owned the GICs; what arrangements she made for their safekeeping; how she received, cashed and deposited the annual interest cheques; how she used the interest income; what arrangements she made to surrender the GICs at maturity and to reinvest the capital; and to what extent she relied on her father (the appellant) to perform some of these functions. Also, she could have traced the use of the capital and annual interest from 1985 to the time of hearing. Any daughter giving such testimony would have been subject to cross-examination, and an obvious question would be why none of the interest income from the GICs was reported on a timely basis for income tax purposes. The uncontradicted evidence of the respondent's witnesses is that not one dollar of interest from GICs was reported by the appellant or any of his daughters for the years 1982 to 1985 inclusive until after an auditor from Revenue Canada, Taxation began in 1985/86 to review the appellant's income tax returns and question the failure to report significant interest income from GICs.

Lise Pelletier born in 1961 is one of the appellant's daughters. In April 1985, she filed her income tax return for 1984 showing an Ottawa residence and reporting only employment income of $4,967.53 from two Ottawa employers. In April 1986, she filed her income tax return for 1985 reporting only employment income of $7,117.82 from one Ottawa employer. Copies of those returns were filed as exhibits by the respondent. The appellant filed as Exhibit A-4 a T1 General Return for 1984 with the name "Lise" printed on the front but otherwise not filled in. Attached to Exhibit A-4 is a copy of a letter from Delbert Plourde, C.A. (the appellant's accountant) dated August 1, 1985 and addressed to Revenue Canada, Taxation. Mr. Plourde's letter has Lise Pelletier’s name, her Social Insurance Number and the 1984 taxation year in the reference line; and he asks Revenue Canada to add certain items (an aggregate of $13,007.56) to Lise's reported income for 1984. One of the items to be added is interest in the amount of $9,902.05 from Society Banque Nationale, and there is attached a T5 information slip issued by Société Banque Nationale to Lise for 1984 showing interest of $9,902.05.

Although Lise Pelletier was not a witness in this appeal and there is no evidence concerning her character, I assume that she is totally honest and would report all income of which she had knowledge. After making that assumption, I have to ask why she reported only employment earnings of $4,967.53 in her 1984 return when the appellant's accountant wrote to Revenue Canada, Taxation in August 1985 (four months after Lise filed her 1984 return) stating that she had interest income of $13,007.56 in 1984? I draw the inference that when Lise filed her 1984 return in April 1985, she had no knowledge of this interest income in the amount of $13,007.56. And if she had no knowledge of interest income which was more than 250 per cent of her employment earnings, can it be said that she was the beneficial owner of the interest income? If the appellant is truthful in stating that the GICs were owned beneficially by the daughters, what is the purpose of gifting to an adult daughter like Lise a large sum of money which produces annual interest income of $13,000 if she does not know about the gift or the possible enjoyment of $13,000 in annual interest?

Similar questions arise concerning another daughter, Monique. Exhibit A-2 shows that she received interest income of $11,690.25, $14,363.15 and $22,637.33 in 1983, 1984 and 1985 respectively. The respondent entered as Exhibits R-10, R-11 and R-12 copies of the appellant's income tax returns for 1983, 1984 and 1985 respectively. For 1983 and 1984, the appellant claimed four daughters (Madeleine, Lise, Pauline and Monique) as dependent children indicating that neither one had any net income. Exhibit R-12 (the 1985 return) does not claim any children as dependants. There is a real conflict among certain exhibits: the appellant's income tax returns for 1983 and 1984 (Exhibits R-10 and R-11) claim Lise and Monique as dependants with no net income; Exhibit A-2 shows Monique with significant interest income in 1983 and 1984; Exhibit A-4 shows Lise with significant interest income in 1984; and Lise's income tax return for 1984 shows only employment earnings. Not only is there a conflict among these exhibits but I think I am correct in stating that there was no document entered in evidence which unequivocally supported the appellant's oral statements concerning beneficial ownership of the GICs.

The appellant testified that, although he arranged for the purchase of the GICs in the names of the various daughters and cashed many of the annual interest cheques issued to those daughters as the registered holders of the GICs, each daughter was the beneficial owner of any GIC registered in her name and any annual interest derived therefrom. Assuming those statements to be true, the appellant should have been able to produce appropriate documents proving: (i) that he kept separate records for the investments held for each daughter; (ii) that he remitted to each daughter the amount of any annual interest cheque which he cashed as her agent; (iii) that the principal amount of each GIC was remitted to the registered holder at maturity or reinvested only in her name; and (iv) that there was no mingling of any principal amounts or annual interest receipts so that each daughter could know with certainty what she owned. The appellant offered no documentary evidence whatsoever to prove any of the above circumstances.

Mr. John Landry, an employee of Revenue Canada, Taxation, was one of three witnesses called to testify on behalf of the respondent. Mr. Landry stated that in early 1986 Revenue Canada, Taxation had numerous T5 information slips showing interest income in the names of the appellant, his wife and some of his daughters which they could not match with any reported income. Following an investigation, Mr. Landry met with the appellant and his accountant (Mr. Plourde) for about three hours at the appellant's office in Edmundston on May 26, 1987. Mr. Landry made notes of the meeting which he referred to when testifying. According to Mr. Landry, the only purpose of the meeting was to discuss the significant amounts of interest income shown on the T5 slips. Mr. Landry quoted the appellant as having made statements in the following terms:

— I set up sort of a trust, not a true trust, a trust not a trust in name, but sort of like a trust to create funds for my children to have some protection for them. It's my capital. I control the funds. I determine who will benefit ultimately. I make the decisions on it. And whoever has the most need in the future will receive those funds.

— If a certificate comes due and I see that a particular daughter has more need than another one, I will buy the certificate in her name. If another one has more need, I will put the certificate in her name.

Mr. Landry stated that he was able to find a pattern of conduct under which the appellant would subscribe for a GIC in the name of a daughter; endorse the interest cheques which were subsequently received with respect to that GIC; and deposit those cheques in his own account. By way of example, Mr. Landry produced Exhibits R-22 and R-23 which were described as follows:

R-22 Copy of an application for a GIC in the amount of $25,000 with annual

interest at 12.5% dated April 23, 1984 in the name of Lise Pelletier but apparently signed by the appellant. Attached are copies of two cheques dated April 23, 1985 and 1986 each in the amount $3,125 payable to Lise Pelletier being annual interest on the GIC. Each cheque was endorsed in handwriting with the words" Lise Pelletier per P. Pelletier, Attorney", and Mr. Landry said that the handwriting appeared to be that of the appellant.

R-23 Copy of an application for a GIC in the amount of $50,000 with annual

interest at 11.25% dated November 18, 1983 in the name of Lise Pelletier but apparently signed by the appellant. Attached are copies of two cheques dated November 18, 1984 and 1985 payable to Lise Pelletier being annual interest on the GIC. Each cheque was endorsed in handwriting with the words" Lise Pelletier per P.E. Pelletier, her Attorney", and Mr. Landry said that the handwriting appeared to be that of the appellant.

Mr. Landry explained in evidence how he traced some of these annual interest cheques directly into the appellant's bank account:

What I did do with some of these—but not all of them—I did trace some of these particular interest cheques to Mr. Pelletier's account either at Central Trust or at the Banque National. That made me conclude that, in fact, he controlled the funds. He admitted it. He told me he controlled the funds. It was his decision. I saw no trust. There was no trust agreement, as far as I was concerned.

I cannot find any evidence of a trust other than the few bland statements made by the appellant. I am satisfied that the daughters did not have any knowledge in the years 1982, 1983, 1984 or 1985 that they were the alleged recipients and owners of significant interest income. With respect to Category 1, the appellant has not only failed to discharge the onus of proof but the evidence introduced by the respondent (documents and oral testimony) is very strongly against the appellant. Counsel for the respondent relied on the decision of the Federal Court of Appeal in Atinco Paper Products Ltd. v. The Queen, [1978] C.T.C. 566, 78 D.T.C. 6387 in which Urie, J., delivering judgment for the Court, stated at page 577 (D.T.C. 6395):

I do not think that I should leave this appeal without expressing my views on the general question of transactions undertaken purportedly for the purpose of estate planning and tax avoidance. It is trite law to say that every lawyer is entitled to so arrange his affairs as to minimize his tax liability. No one has ever suggested that this is contrary to public policy. It is equally true that this Court is not the watchdog of the Minister of National Revenue. Nonetheless, it is the duty of the Court to carefully scrutinize everything that a taxpayer has done to ensure that everything which appears to have been done, in fact, has been done in accordance with applicable law. It is not sufficient to employ devices to achieve a desired result without ensuring that those devices are not simply cosmetically correct, that is correct in form, but, in fact, are in all respects legally correct, real transactions.

If the appellant is relying on the existence of a trust to prove that some of his daughters were the real beneficial recipients and owners of certain interest income that has been taxed in his hands, the evidence was not adequate to prove that any such trust existed.

I have reluctantly concluded that I cannot accept the appellant's testimony concerning ownership of the GICs for a number of reasons: his statements are not consistent with his own income tax returns for 1983 and 1984; his statements are not consistent with Lise Pelletier's income tax return for 1984; his statements were contradicted by Mr. Landry, a credible witness for the respondent; none of the appellant's adult daughters appeared as a witness to corroborate his statements; and the appellant did not produce any document in evidence which unequivocally corroborated his statements. On this first issue involving Category 1,1 hold that the respondent was justified in adding to the appellant's reported income for 1982, 1983, 1984 and 1985 interest received from GICs in the aggregate amount of $123,602.85.

Part of the appellant’s Exhibit A-4 was a copy of a notice of reassessment issued to Lise Pelletier on June 27, 1986 for her 1985 taxation year increasing her reported income for 1985 by approximately $11,780. I am not able to determine whether this amount of $11,780 is part of the $48,590.79 which was added to the appellant’s income for 1985 and is under appeal in Category! In my view, it would not be proper for the respondent to assess tax knowingly on the precise same income in the hands of two different taxpayers unless the respondent had decided that such assessing action was to be part of an application to this Court under section 174 of the Income Tax Act, but I have not had the benefit of hearing counsel on this matter. There was no application under section 174 in connection with these appeals and, having decided Category 1 against the appellant, I assume that the respondent will take any steps which may be necessary to ensure that the interest income taxed in the appellant's hands in Category 1 is not taxed a second time in the hands of any other person.

CATEGORY 2. When issuing notices of reassessment to the appellant for the years 1980, 1981, 1982, 1983 and 1984, the respondent added to the appellant's reported income the amounts listed above (in the aggregate of $48,208.42) which were each identified as" interest coming from sources invested in a trust ‘Albertine Pelletier'". The appellant testified that Albertine Pelletier was his mother who had died in 1960. I should note that the appellant's wife and mother have the same first name. Although the appellant in his notice of appeal referring to these amounts stated that" revenues belonging to a trust for his mother have been included in his income contrary to law", no evidence was led by the appellant as to why these amounts should not be part of his income. The appellant has failed to discharge the onus of proof with respect to Category 2 and I hold that the respondent was justified in adding to the appellant's reported income for 1980 to 1984 inclusive interest in the aggregate amount of $48,208.42.

CATEGORY 3. The appellant purchased two rental buildings in Edmunston, N.B. in March and October 1983. The buildings were in a bad state of repair and the City issued an order to repair or demolish them. Notwithstanding the bad state of repair, the appellant had the buildings rented in 1983 and 1984 but he did not report any rental income. Even after the assessments and reassessments referred to above in which the respondent added amounts of rental income to the appellant's reported income for 1983 and 1984 and then reduced the rental income by accepting certain expenses, the appellant failed to provide information concerning the cost of the buildings upon which a claim for capital cost allowance could be based.

There was put in evidence as Exhibits R-4 and R-6 certain correspondence between M. Jacques St. Martin, C.A. (an accountant in Quebec City retained by the appellant) and M. Charles Melanson (an officer of Revenue Canada) dated respectively February 9 and March 24, 1988. In the more recent letter, Mr. Melanson referred to the rental income and the need for the appellant or Mr. Plourde to provide evidence concerning the cost of the buildings. No document was provided until the hearing of this appeal when the appellant introduced as Exhibit A-5 a capital cost allowance schedule. Exhibit A-5 had been prepared by Mr. Plourde just two weeks before the hearing. Apparently, it is the appellant's position that Exhibit A-5 can be the basis for his claim of capital cost allowance with respect to the buildings but, in my view, Exhibit A-5 is not adequate because it does not show the total cost of either property or an allocation of that cost between land and building. I refer to the correspondence (Exhibits R-4 and R-6) only to indicate that the appellant was warned as early as March 1988 that the respondent needed evidence concerning the cost of the buildings.

Exhibit A-5 does not prove the cost of any property; it is simply a schedule prepared by Mr. Plourde and disclosed to the respondent for the first time at the hearing of these appeals. Mr. Plourde did not testify and no amount in his schedule (Exhibit A-5) was proved by an independent source like an agreement of purchase and sale, a registered deed or a mortgage foreclosure document. I give no weight to Exhibit A-5. As a practical matter, however, I think the appellant is entitled to deduct some amount of capital cost allowance with respect to the two rental buildings. For 1983 and 1984, the respondent has determined that the appellant had net rental income of $7.34 and $5,984.79 respectively, by matching revenues with expenses and with no deduction for capital cost allowance. On an arbitrary basis and without relying on Exhibit A-5 in any way, I would recognize some unspecified amount as the allocated cost of the buildings and allow $7.34 as capital cost allowance for 1983 and $2,000 as capital cost allowance for 1984. As a result of such allowances, the appellant's rental income in Category 3 is reduced to nil in 1983 and to $3,984.79 in 1984.

CATEGORY 4. There was very little testimony concerning the amounts from two mortgages added to the appellant's reported income for 1983 and 1984. The appellant acknowledged that he had arranged the two mortgages and placed them in the names of his wife (Albertine) and daughter (Lise) as mortgagees. The appellant was cross-examined concerning the amounts received from each mortgage in each year. He had no problem concerning amounts received from the mortgage in his wife's name but he stated that the mortgage in his daughter's name was in default at times and it was his recollection that the amounts from this latter mortgage were on account of principal and not interest. The amounts added to the appellant's reported income from the mortgage in his daughter's name were:

These amounts were set out in detail in the respondent's" Reply to Notice of Appeal" dated four months prior to the hearing of this appeal. The onus was on the appellant to show that the respondent's amounts were wrong. When the appellant acknowledges that he arranged both mortgages, all he had to do was produce his own records to show what amounts were received with respect to the daughter's mortgage and whether such amounts were principal, interest or a combination of both. The appellant produced no documentation whatsoever in connection with these mortgages and I am left to conclude that he has failed to discharge the onus of proving that the assessments for 1984 and 1985 are wrong in Category 4. This is another instance where, although both mortgages were in existence in 1984 and 1985 and had been obtained by the appellant, there is no evidence that any person (specifically, the appellant's wife or his daughter Lise) was reporting the income from those mortgages for income tax purposes.

CATEGORY 5. The amounts of interest which the respondent disallowed as deductions in computing income are set out above. The appellant produced as Exhibit A-6 a letter from his bank confirming that he had paid those amounts of interest with respect to his line of credit. During the years 1981 to 1985, the appellant was still engaged in the practice of law and I assume that he had a line of credit in connection with the practice of his profession. Also, from time to time in his lengthy oral evidence, he referred to occasions when he would surrender a GIC at maturity and, if the principal amount of the GIC plus unpaid interest needed an additional amount to reinvest in a further GIC at a higher multiple of $1,000, he would borrow such additional amount. There was no evidence that the appellant lived lavishly or borrowed money for personal pleasures like a summer cottage or a sailboat. I would allow the appeal with respect to Category 5 and permit the deduction of the following amounts of interest in computing income:

CATEGORY 6. The appellant described certain occasions when he was sued or when a former client filed a complaint against him with the New Brunswick Law Society. On those occasions, he was required to retain outside counsel and, in my view, the expenses he incurred to retain such outside counsel were appropriate deductions in computing his income from the practice of law. In evidence, the appellant produced documents showing that he paid $1,374.46 to Ryan, Graser & Smith (an Edmunston law firm) in 1985; and he also produced a 1985 invoice from Georges U. Cyr in the amount of $275. The appellant could not explain the gap between the aggregate amount of $1,649.46 representing these two legal bills and the amount of $19,337.10 which is the amount of legal fees disallowed as a deduction in 1985. He was emphatic, however, that he was required to pay $5,000 as the "deductible amount” in connection with professional liability insurance maintained by the New Brunswick Law Society following a claim made by a former client. In the overall context of the appellants testimony with respect to Category 6, I am inclined to believe that the $5,000 amount was actually paid. I would therefore allow the appeal in part for Category 6 and hold that the appellant is permitted to deduct the aggregate amount of $6,649.46 as legal fees paid in 1985.

CATEGORY 7. For each of the years 1983 and 1984, the appellant deducted a non-capital loss in the amount of $20,000. The appellant claims that such losses arose from disbursements which he laid out on behalf of clients but was later unable to collect from the clients. The respondent disputes the amounts for two reasons. Firstly, the respondent argues that the amounts have not been verified by any of the normal books and records like client ledger cards, client files, trust account entries, cancelled cheques, bank statements or other records used in the appellants practice of law. The only documentary evidence relating to client disbursements are two lists. Exhibit A-9 is a ten-page list with three columns showing the file number, the client's name and the disbursement amount. The last three pages of A-9 do not show any file number and there is no way of determining from A-9 the date when a particular disbursement was made. The aggregate of all amounts in A-9 is approximately $60,000.

Exhibit R-5 is a different ten-page list with three columns showing the year, the client's name and the disbursement amount. Exhibits A-9 and R-5 were prepared at different times by or on behalf of the appellant. R-5 was provided to the respondent by M. St. Martin when the appellant's notices of objection for the years under appeal were being discussed. The aggregate of all amounts in R-5 is approximately $19,000 and a big majority of the amounts in R-5 were disbursed prior to 1980. This last fact becomes important when considering the respondent's second reason for disputing the amounts.

Charles Melanson, employee of Revenue Canada, Taxation testified as a witness for the respondent. He was involved back in 1981/82 with processing the appellant's objections for 1977, 1978 and 1979. Mr. Melanson stated that the appellant had attempted to deduct uncollected disbursements (on behalf of clients) for the years 1977, 1978 and 1979 in the amount of approximately $19,000. The respondent had challenged such deductions; added some unreported income in his assessments for those years and proposed the imposition of penalties. After the appellant had filed notices of objection, a settlement was negotiated in which the appellant accepted taxation on the unreported income; he was allowed to deduct the sum of $19,000 even though the alleged uncollected disbursements were not verified by independent documents; and the respondent withdrew the penalties. Mr. Melanson stated that the appellant was told back in 1981/82 that no further deductions of uncollected disbursements would be accepted unless they were verified and could be shown to have been paid after 1979. Having granted the deduction of $19,000 for unverified disbursements in 1977, 1978 and 1979, the respondent did not want the appellant to be deducting the same items twice.

I found Mr. Melanson to be a credible witness. I believe his description of the negotiation for the earlier years and the appellant acknowledged in cross- examination the substance of what Mr. Melanson stated in detail in subsequent testimony. Even without Mr. Melanson's testimony, I would have found that the appellant had failed to discharge the burden of proof in connection with these two amounts of $20,000 in 1983 and 1984. Having heard and accepted Mr. Melanson's testimony, I find it incredible that the appellant would make these claims to deduct $40,000 in respect of uncollected disbursements and come to court with such inadequate documentation to prove that the disbursements were incurred and never collected. The appeal in respect of Category 7 is dismissed.

The appellant in his pleadings raised the issue as to whether reassessments for some of the years under appeal might be outside the time permitted for reassessment under subsection 152(4) of the Income Tax Act. In argument, however, counsel for the appellant acknowledged that he had not been able to prove the date of any original assessment which would permit him to argue that any particular year was statute-barred. This is not surprising given the fact that the appellant did not file his income tax returns on time and sometimes filed only after receiving a demand from the respondent. The issue of statute- barred years was not pursued in evidence or argument.

The remaining issue concerns penalties assessed under subsection 163(2) of the Act. The first reassessments for all six years were issued on April 30, 1987. At that time, penalties were levied under subsection 163(2) for 1980, 1981 and 1982 but similar penalties were not levied for the three subsequent years. In response to the appellant's notices of objection, the three earlier years were confirmed on August 25,1988 and the respondent reassessed the three later years on the same date to levy penalties under subsection 163(2). Counsel for the appellant argued strongly that no new information came to the respondent between April 30, 1987 and August 25, 1988 to justify the assessment of penalties for the three later years but I am satisfied from the respondent's witnesses and their documents dated from January to March 1987 that it was the respondent's very clear intention to levy penalties under subsection 163(2) for all six years before the first reassessments were issued on April 30, 1987. I accept the respondent's testimony that the failure to assess a penalty under subsection 163(2) on April 30, 1987 for the taxation years 1983, 1984 and 1985 was due to a clerical oversight. In any event, it is unlikely that the reassessments issued on August 25, 1988 for the taxation years 1983, 1984 and 1985 were outside the time permitted for reassessment under subsection 152(4).

The real question is whether and to what extent the penalties should be sustained. The penalty under subsection 163(2) is imposed on a person who “knowingly, or under circumstances amounting to gross negligence" makes a false statement in a return. As I understand the penalty recommendation in Exhibit R-14 filed by the respondent, the penalties levied under paragraph 163(2) were in respect of the following:

Category 1—all amounts added

Category 2—all amounts added

Category 3—all amounts added

Category 4—all amounts added

Category 7—all amounts disallowed

I have no hesitation in sustaining the penalty under subsection 163(2) with respect to amounts added to the appellant's reported income under Categories 1, 2 and 4. These are amounts which I think the appellant knowingly omitted from his income tax return when he knew that no other person would report such amounts as income. Concerning Category 3, I will give the appellant the benefit of the doubt and delete the penalty because the appellant may have thought that there would be enough capital cost allowance to bring the net rental income down to nil. Indeed, there may have been enough capital cost allowance but the appellant failed to prove any cost with respect to the buildings and I therefore awarded only small arbitrary amounts.

Concerning Category 7, I would delete the penalty. This is not like Categories 1, 2 and 4 where income was omitted in the hope that it would not be taxed. The appellant deducted two large rounded amounts ($20,000 in 1983 and 1984) which could easily be flagged by the respondent and challenged for proof of payment or loss. I formed such a low opinion of the appellants sloppy bookkeeping methods in his law practice that I believe he probably did make many disbursements on behalf of clients which he simply failed to collect through neglect. He probably thought when claiming $20,000 that he would be able "to prove" that amount for each year. Having retired in 1987, however, I assume he had lost control of his files by the time the appeal was heard and was unable to prove any disbursements. His inability to prove the amounts claimed as disbursements made but not recovered from clients does not mean that he knowingly made a false statement when completing his income tax returns for 1983 and 1984. Therefore, although the appeal is dismissed in respect of the two amounts of $20,000, I think that the penalty under subsection 163(2) with respect to those two amounts should be deleted.

If there were penalties assessed under subsection 163(2) with respect to other amounts not in issue before me, I make no finding on such penalties. And if I should be mistaken concerning the amounts in issue on which penalties were assessed under subsection 163(2), then counsel may make further submissions within 60 days following judgment. In summary, the appeals for 1980 and 1982 are dismissed. The appeal for 1981 is allowed to permit the deduction of interest paid in Category 5. The appeal for 1983 is allowed in order to deduct such capital cost allowance as may be required to reduce the rental income to nil in Category 3, to permit the deduction of interest paid in Category 5, and to delete the penalty under 163(2) concerning Categories 3 and 7. The appeal for 1984 is allowed in order to deduct $2,000 as capital cost allowance to reduce the rental income by $2,000 in Category 3, to permit the deduction of interest paid in Category 5, and to delete the penalty under subsection 163(2) concerning Categories 3 and 7. The appeal for 1985 is allowed in order to permit the deduction of interest paid in Category 5, and to permit the deduction of legal fees in the amount of $6,649.46 in Category 6. If any statement in this last paragraph is not consistent with the above reasons for judgment, counsel may make further submissions within 60 days following judgment.

Appeals allowed in part.