Richard Allan and David Allan v. Minister of National Revenue, [1992] 1 CTC 2406, 92 DTC 1661

Kempo. T.C.C.J.:—The appeals of Richard Allan, appeal number 89-3025 were heard immediately prior to the hearing of this appeal which occurred in accordance with and pursuant to the appellant's agreement in that respect. Counsel for the appellant advised the Court that the evidence tendered in the Richard Allan appeals is adopted and is to be applicable to the appellant's own appeals as all issues and circumstances were identical.

No useful purpose would be served in reviewing the facts of this appeal since they are virtually identical for all material purposes to those set out in my attached Reasons for Judgment in the Richard Allan appeals.

For the reasons given in the Richard Allan appeals, the appellant's appeals are allowed for the 1985, 1986 and 1987 taxation years and the matters are referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that the penalties imposed for each such year 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") are eliminated.

One-third of party-and-party costs are awarded to the appellant which are to be shared with the appeals of Richard Allan, 89-3025.

The appeals of Richard Allan were respecting his 1985, 1986 and 1987 taxation years. They arose out of the respondent's reassessments which had been premised on an understatement of net income for each year in the respective amounts of $6,919.08, $14,661.63 and $17,835.90 as determined on a net worth basis. Penalties were levied pursuant to subsection 163(2) of the Income Tax Act (the "Act") for each year in relation to the alleged understatements of income.

At the commencement of the trial, counsel for the appellant advised the Court that only two issues would be raised for the Court's adjudication. One concerned the penalties levied for all three years under appeal and the other involved the 1987 year's understatement of income, the 1985 and 1986 years being admitted in this respect.

On the first issue, the appellant denied he was negligent within the meaning of subsection 163(2). On the second, his position was that the alleged 1987 unreported amount of $17,835.90 was overstated by an unpaid loan amount of approximately $10,000 and by amounts involving his estimated personal expenditures for the year.

Viva voce evidence was heard from the appellant, from his brother David Allan ("David"), from his other brother Michael Allan ("Michael") and from his accountant Mr. Gerald Harris.

The respondent called Staff Sergeant Patrick Hayes of the Ottawa Police Department. His involvement in this case arose out of a police raid of the appellant's business premises as later described.

During the years under appeal the appellant and his brother David were running an established escort-oriented telephone referral service. It was conducted out of a small rundown apartment which they both occupied as a residence as well.

The basic business operation involved ten to fifteen telephone lines emanating from numerous yellow-page advertisements ostensibly representing different escort agencies. Individuals seeking escorts would telephone an advertised number and an answerer located in the business premises would contact an available escort who in turn would contact the customer directly to make the necessary rendezvous arrangements. Ten to fifteen escorts were on call from time to time as required.

The business was cash oriented. All escorts used aliases. Credit cards were sometimes employed but only by the appellant processing them through another business merchant who was paid a negotiated percentage fee or discount based on its face value. It was done this way because this business was not wanted by the credit card agencies. It also served to protect customer anonymity.

The daily revenue record keeping system was explained by the appellant thusly:

Q. What can you tell us, Mr. Allan, about the nature of the records that were kept, the ones that you said the police had at the time your returns were being prepared?

A. Our records were pretty simple. We had basically two columns. We had a" We Owe" column and a They Owe" column.

Q. Are you speaking of your revenue records or your expense records?

A. Revenue records. There was a "We Owe" column and a“ "They Owe” column. Q. What does that mean?

A. The "We" was the office, my brother and I.

Q. "We Owe" who?

A. The girl, whoever the girl was, the call. It was a running balance. If they owed us money, it would be in the They Owe" column

Q. How did you record the receipt of the funds?

A. In that same book. We would put it down as either" received"—if it was in our column, the "We Owe" column—it was just a balance they kept running. If they owed us and they had paid us, then we would write down "paid", and then we would start from zero from that point on.

Q. Did a change in the running balance mean that money had been received, or that it had been disbursed?

A. Yes, it changed regularly, depending on how long the girl worked. If she didn't work for a week, then obviously it would change.

Q. So there was one of these" We Owe/They Owe" sheets kept for each individual escort?

A. No. It was for the whole day.

Q. So they were daily sheets.

A. Yes.

Q. If one examined those two-column sheets on a daily basis, would you be able to. . .looking at the balances indicated on the last entry. . .would you be able to tell what the daily receipts were of cash?

A. We were capable of doing that. . . .[T. 117 to 119]

The appellant and his brother David began the business in 1983 and had never filed income tax returns. The explanations advanced were the appellant's belief that there was some sort of two-year leeway tax-free period for businesses and that he was not knowledgeable in business or tax matters. Prior to this venture the appellant had worked in construction labour and in the printing trade. He completed a high school (grade eleven) education and had taken some university level courses. His brother Michael had worked in the business as a part-time receptionist and bookkeeper during the subject time frame, attending university thereafter and gaining accounting and tax related knowledge by recent accomplishment. The appellant and Michael and David were each around thirty years of age during the material times.

The described standard of living of the appellant and of his brother David was modest. They shared the apartment expenses for a six-month period June 1986 to January 1987. Their major annual personal expenditures involved mortgage payments on a jointly owned cottage. Both were anxious to pay off this asset as quickly as possible. According to the schedule of personal expenditures attached to the respondent's reply to notice of appeal, the personal expenditures (combined for David and Richard Allan) looked like this:

general operation, miscellaneous,

personal assets (Estimate as

provided by taxpayer)

Additional purchases as per

receipts:

Encyclopedia Britannica			2,000.00
Harry Rosen			893.99
Colonial Furniture			12,698.22
Shorney's Opticians			321.00
Stile Farm Insurance (Drummond)			226.00
Down Payment on cottage property	17,000.00
Payments made on cottage mortgage		33,113.51	33,112.51
	—
18,000.00
	$36,999.50	$56.132.51	$54,759.11

includes an amount of $3,381.00 representing 30% personal use portion of total cost of 1984 Buick of $11,270.00.

Following the police raid on the business, infra, the appellant and David retained the accounting services of Mr. Harris to prepare their tax returns for the years 1985 to 1987 inclusive. The returns as prepared and filed for the appellant and for David declared total income for each as follows;

$11,710 for 1985

$16,570.50 for 1986

$18,909 for 1987

Contrary to the appellants assertions in this respect, Mr. Harris specifically denied any involvement with the personal expenditures of the appellant and David. Rather, he testified that his activity had been confined to constructing financial statements and the returns based on the business—related data supplied to him by the Allan brothers. Needless to say the reported personal income fell far short of including the annual mortgage payments made by them for the cottage.

Three days after the police raid the cottage was transferred to the appellant's father. The appellant stated that since he and David were then under criminal investigation, the purpose of the transfer related to keeping the cottage in the family. David, on the other hand, testified that the transfer was done primarily to mollify the private mortgage holder and on cross-examination he steadfastly maintained that its registration, so soon after the raid, was mere coincidence. The cottage was, without doubt, a very important and highly valued personal asset of both individuals. Indeed David specifically testified that he and the appellant “lived” to pay off the cottage and that the profits made from their business went directly to fulfil that purpose.

As credibility was essentially the major issue impacting on all matters raised in the appeals, the veracity and reliability of the oral testimony surrounding this particular subject matter is of prime concern. Both David and the appellant said they had discussed the cottage expenditures with the accountant with the view to their deductibility. This discussion was confirmed by Mr. Harris who also stated that he had not involved himself with personal expenditures in preparing the returns. It may be inferred that if he had directed his mind in this way it is likely he would have twigged to the fact that the reported income amount was low. Nonetheless, and returning to the matter of credibility, the disparity of the testimony between the appellant and his brother David concerning the motivation for transfer of the cottage remains of significant concern.

It is now appropriate to deal with the testimony of the appellant and David with respect to the purported $20,000 cash loan made to the business by one of its female escorts who was then also involved in a personal relationship with the appellant. The lender's name was said to be Melissa Dupuy. She did not appear to testify. The appellant knew of her mother's whereabouts but made no serious attempt to find her for the purposes of the trial. Apparently she was only 18 years old at the time of the loan. It was the evidence of the appellant, of David and of Michael that during the week prior to the day the alleged loan was actually made they had decided that the business could use extra funds to acquire two used vehicles and more telephone lines and advertisements. Michael said he was already holding a vehicle worth $8,000 in his name solely for the benefit of the business. The alleged proposal was that Melissa Dupuy was to loan the business $20,000 and that she was to receive the $8,000 auto in part payment.

On the evening of Friday, January 31, 1987 at about 8:00 p.m. some ten to fifteen police officers entered the business apartment with a warrant for search and seizure on the grounds of alleged illicit activities. The appellant was then in Toronto setting up the business there. Present were David, Michael and a telephone receptionist. The latter two were immediately taken to the police station. David remained in the premises and witnessed the seizure of all personal and business records. He informed the police that $20,000 in cash was in a safe on the premises. The safe was opened and $19,900 in cash was removed ($100 was retained by the appellant, he said, when he received the amount from Ms. Dupuy), counted and seized. In the company of his lawyer, David received the money back from the police 11 days later. According to Staff Sergeant Hayes, when David first asked for the return of the cash he said the money did not belong to him but that after speaking with his lawyer he said the money had belonged to him. David, Michael and the appellant were all charged with prostitution related charges. None were found guilty.

Returning to the chronology of events, Michael said he signed the transfer of vehicle ownership the day following the raid (Saturday, February 1). On Monday, February 3, the transfer was registered in Ms. Dupuy's favour. The same day a prominent article had appeared in the Ottawa Citizen newspaper reporting simultaneous police raids on all the escort agencies in the area. The article made reference to one of the operators of an escort business then being under investigation for tax evasion. David said he never ever read the paper. The appellant said he had remained in Toronto to avoid immediate arrest but inferred he was probably made aware of the contents in the newspaper report. That day also saw title to the cottage being transferred to the appellant's father. The appellant, Michael and David all denied that the transfers of the auto and cottage were in any way tax motivated.

The appellant claims that the $19,900 found in the safe was a loan and that the respondent had erroneously included one-half into his income for the year. The other half was included in David's income for the year and is the subject of David's appeal which, at the conclusion of the appellant's trial, was agreed to be heard upon common proof with the appellant's appeal.

Was the $19,900 cash in the safe the alleged Dupuy business loan, or was it business income or something else? Ms. Dupuy was then a professional escort and only 18 years of age. The appellant made no serious effort to find her to testify. The alleged loan was not documented at the crucial time. The following evidentiary particulars were submitted as supportive of the loan:

— the appellant, Michael and David all said they had discussed a business loan being made one week before;

— Ms. Dupuy allegedly had agreed to accept the $8,000 car in part payment of the loan. Michael said he signed the car transfer solely for the above purpose and recalls that it had been done after the funds were put in the business safe;

— a handwriting expert's conclusion (Exhibit A-11) was that the signature of Melissa Jeanicot Dupuy appeared on the following written receipts:

— August 4, 1987 for $3,000 in favour of Michael (Exhibit A-2),

— undated, for $4,400 in favour of the appellant (Exhibit A-5),

— November 10, 1987 for $4,000 in favour of the appellant, (Exhibit A-4),

— the signature on the August 10, 1987 receipt for $4,000 in favour of Michael was not that of Ms. Dupuy (Exhibit A-3);

— Michael and the appellant testified that they had personally delivered all of the above cash loan repayments for which they had obtained the above receipts signed (except for the last one) in their presence by Ms. Dupuy;

— all three brothers testified that Ms. Dupuy was promised repayment within a year (the appellant said it was to be within six months) with a bonus in an unspecified amount and that an overall $23,400 had been repaid to her, by cash and car transfer, by November 10, 1987. This was long before the matter arose as a tax issue.

The Court must weigh the above-noted testimony and documents in light of the following evidence which weighs materially against the appellant:

— With respect to the gathering of and payment of the alleged cash loan:

— The appellant said he received the loan amount in denominations of $100, $50 and $20 bills, that he had accompanied Ms. Dupuy to one bank on the corner of Elgin Street just across from the new Court House and that after she had come out of the bank they returned to her apartment, counted the money and then she gave it all to him on the day before the raid. He said that he went to the business office around 11:00 a.m. or 12:00 noon the next day (the day of the police raid), that he showed the cash to David and it was then put in the safe following which he left;

David said the loan amount was all in $100 bills and that the appellant had brought the money to the office at around 6:00 p.m. of the day of the raid. He also testified that he had accompanied the appellant and Ms. Dupuy the day before to one of three different banks and that it had taken a half day for Ms. Dupuy to get the cash together;

Michael said the cash was in the office safe for a day, or little more than a day, before the raid;

— an alleged $3,400 cash bonus was said to be given to Ms. Dupuy on a $20,000 loan of which only $12,000 was notwithstanding one to three days following its advance. This assumes the $8,000 car transfer was in fact part payment of the purported loan;

— the personal relationship between the appellant and Ms. Dupuy had terminated shortly after the raid. The appellant said that she had gone away in August of 1987 notwithstanding his evidence of having given her 4,400 in cash in October and a further $4,000 in November. Upon being cross- examined about her whereabouts concerning her non-attendance at the trial, he had this to say:

Q. When did she stop working for the escort agency?

A. August of 1987, maybe. Somewhere around there.

Q. I suggest to you, sir, that as a result of the contacts that you would have had with her and that she would have had with others in your employ, you would have had many leads to follow up in terms of trying to locate this woman.

A. Afterwards?

Q. That is right.

A. No.

Q. She worked there for a year and a half. You went out with her for six months.

A. Eight months. Yes.

Q. Eight months. I am suggesting that as a result of that knowledge, you could have contacted any number of people to try to determine where she is located.

A. After we stopped seeing each other, basically around February some time, she worked for us until around August, and after that she basically disappeared. I don't know where she went. That is typical of most of the girls in the escort business. They just usually—you never hear from them again.

Q. She severed all ties with Ottawa.

A. As far as I know. From what I heard, she moved to California.

Q. And none of the people that she knew or none of the people that you knew through her would have been able to trace where she is located in California. She didn't tell anybody where she was going.

A. We had no mutual friends, basically. Our relationship was not a deep long- lasting type of relationship. It was just a relationship based on physical attraction. That was it, basically. We were good friends. She helped me out and I helped her out. She left and went her way. She went her way, and that was the last that I ever heard from her. I didn't pursue her or anything at all. I didn't at that point think that the $20,000 loan was going to be an issue in my tax situation. When she left and went her way, had I known that, I would have tried to keep in touch with her so that I could have asked her to come here and testify for me on my behalf. [T. 165, 166]

Analysis

It has oft been said that the trier of fact should not consider each piece of evidence independently. Rather, its examination should be in light of all the other evidence, both direct and circumstantial.

In the case before me all of the documentary evidence originated after the alleged loan had been advanced. That inconsistencies abound respecting its gathering and deposit into the business safe cannot be ignored. Nor can it go by unnoticed that the handling of such a large amount of cash would be an unusual and therefore memorable event for the appellant and his brothers attracting, at the very least, consistent recall respecting all of its pertinent circumstances.

The burden of proof is on the appellant. In my view, what has been established here is that Ms. Dupuy had signed receipts for stated amounts and that she had received title to the vehicle representative of $8,000 in value. What does all this serve to corroborate? The true answer could have been more readily found in favour of the appellant's assertion of a loan repayment if the evidentiary inconsistencies had been minor in nature, of the kind falling within a normal expectation of faulty recall concerning ancillary details. As that has not been the case here, the burden has not been discharged. As noted earlier, credibility remained the active and all-pervasive basic issue throughout. David's testimony respecting the transfer of the cottage on the Monday following the police seizure as being merely a coincidence was, in my view, a total fabrication.

Given all of the above, there is no reason to hold that the respondent was shown to be in error in including one-half of the $19,900 amount into the appellant's 1987 income. Nor on the evidence do I find any reason to disturb the personal expenditure amount used by the respondent in the net worth calculation for that year. While in retrospect the appellant felt it was too high, he was the one who had provided the estimates to the respondent's officials at a much earlier date. Further, he failed to produce convincing testimony as to what the correct amount ought to have been in any event.

With respect to the subsection 163(2) penalties levied, however, different perspectives apply notwithstanding the want of credibility as found above. In my view the appellant was notably negligent in not having examined his return for each year more closely for if he had directed his mind to it, or if Mr. Harris had done so, it is likely it would have been revamped.

The appellant said that the omissions from income arose primarily from the want of records as they had been seized by the police. That was not the whole answer, however, as the appellant and David each knew what their modest living expenses were and what they had paid on the cottage mortgage. Further there is no hard evidence here that the police had refused to produce photocopies of any records essential to the preparation of acceptably accurate income tax returns of the appellant.

My analysis of the whole of the circumstances leads me to the conclusion that the seizure of the records followed by attempts to gain copies in order to assist the accountant all contributed to significant confusion overlying the whole matter. There was negligence here but not gross negligence involving intentional acting or culpable indifference of the kind the subject provision requires; see for example, Venne v. The Queen, [1984] C.T.C. 223, 84 D.T.C. 6247 (F.C.T.D), at page 231 (D.T.C. 6256.)

Conclusion

The appellant's appeals are allowed for the 1985, 1986 and 1987 taxation years and the matters are referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that the penalties imposed for each such year under subsection 163(2) of the Income Tax Act are eliminated.

Counsel for the appellant advised that the evidence tendered in these appeals is adopted by, and is to be applicable to the appeals of David Allan 89-3026 whose appeals and issues are in the identical circumstances as those of this appellant, Richard Allan. No further or additional evidence was presented in this respect. Accordingly, these reasons for judgment will also apply to the appeals of David Allan.

One-third of party-and-party costs are awarded to the appellant which are to be shared with the appeals of David Allan 89-3026.

Appeals allowed in part.