John Dick and Beverly Dick and Dick's Garage Limited v. Minister of National Revenue, [1991] 2 CTC 2034, 91 DTC 811

Taylor, T.CJ.:—These are appeals heard on common evidence in Toronto, Ontario on January 29, 30, 31 and February 1, 1991 against income tax assessments covering the taxation years 1979 through 1985 for each of the appellants. Before, during and after the years in question Dick's Garage Ltd. ("Dick's Garage") carried on the business of an automobile dealer and automobile service centre in Sault St. Marie, Ontario with John Dick and Beverly Dick as active shareholders and directors. The trial proceeded first with evidence from the respondent covering the 1979 and 1980 "statute-barred" taxation years. It was intended that the trial would deal subsequently with the 1981 through 1985 "non-statute-barred" years but as the matter progressed the witnesses for both sides dealt with all the years involved—and on agreement before argument the Court was left with the task of dealing with the determination of the question arising out of the distinction between the 1979-1980 years and the 1981-1985 years using all the evidence provided. I do point out that both parties made every effort to conform as closely as possible to the procedural comments contained in The Queen v. Taylor, [1984] C.T.C. 436; 84 D.T.C. 6459 and other relevant jurisprudence, but a certain amount of overlapping of the evidence resulted between and among the various taxation years.

In view of the conclusions I have reached and which are detailed in these reasons for judgment, little purpose would be served by a complete review of all the testimony and evidence, but that which I consider relevant and critical to my decision will be noted. I do wish to note the careful and detailed analysis and summary work aided by his complete and informative testimony which was provided to the Court by the main witness for the respondent, Mr. Robert Kennedy, an auditor with Revenue Canada.

Analysis

First, I shall deal with the question of the "statute-barred" years 1979 and 1980 for all three appellants.The responsibility to fulfil the conditions required under subsection 152(4) of the Income Tax Act ("the Act") in order to assess rested with the respondent. The main item of physical evidence made available to the Court was the schedule of "unreported income" covering all the years from 1978 through 1985, prepared by the respondent's officials as a result of the audit of the records of the appellants, interviews with the parties and examination of the relevant documents which could be marshalled. The conclusion reached by the respondent resulted in:

(Dick's Garage Ltd.)

. . . adding to the Appellant's income the amount of $127,439 in 1979 and $91,800 in 1980 as unreported cash sales arising from its business as an automobile dealer and service centre. The respondent also assessed penalties under subsection 163(2) of the Income Tax Act on these amounts.

(John Dick)

—to include in the Appellant’s income the following amounts on the basis that the Appellant appropriated these amounts from Dick's Garage Ltd.:

1979	$63,719.69
1980	45,900.13

—and to assess penalties with respect to the alleged appropriated amounts under subsection 163(2) of the Income Tax Act.

(Beverly Dick)

—to include in income the following amounts on the basis that Dick Beverly appropriated these amounts from Dick’s Garage Ltd.:

1979	$63,719.69
1980	45,900.13

—and to assess penalties with respect to the alleged appropriated amounts under subsection 163(2) of the Income Tax Act.

There was some difference of opinion regarding the precise calculations and value of the amounts of assets and liabilities at the start of the critical period— January 1, 1979; business and personal expenditures of the appellants during the period; the assets and liabilities at the end—December 31, 1980; and the valuation basis for the net worth assessments at issue. But it is not my intention nor do I believe requirement to delve into these differences. It would have been highly appropriate, and much appreciated, if the appellants, through their accountant, had provided to the Court an alternative reconciliation of disputed amounts or a schedule similar to that prepared by Revenue Canada upon which the case could have been joined. Instead of doing so, it appeared to me that the appellants in a somewhat disjointed fashion merely took issue with the respondent's summaries of amounts, including the allocation of various amounts to certain years. In this way, the appellants did place their cause at considerable risk, a factor which I considered seriously in the review. It was the simple contention of the witnesses for the appellants that all income for all years from Dick's Garage had been properly reported and accounted for in terms of income tax requirements. The appellants rested on the contention that the excess funds which showed up by the net worth assessments came from gifts to them from the parents of John Dick either sent from Germany or brought to Canada on visits. It was the opposite position asserted by the respondent that the only source of income available to account for the discrepancies shown by the "net worth assessments", was that from Dick's Garage.

I am quite satisfied that there were substantial discrepancies in available cash demonstrated by the "net worth" reconciliation prepared by Revenue Canada. However, there is nothing, not even one item which could link these discrepancies to the alleged source of income—Dick's Garage. In my opinion, and as I understand the case law, it was incumbent upon the respondent to demonstrate at least one clear item of income for each year 1979 and 1980 which arose out of the operation of Dick's Garage—then it would have rested with the appellants to show that the proposition of the respondent—the operation of Dick's Garage as the "source of additional income"—should be rejected by the Court. I would refer with complete approbation to the case of Lucien Venne v. The Queen, [1984] C.T.C. 223; 84 D.T.C. 6247, and in particular to earlier case law referenced in that decision. [1] No “misrepresentation” or "fraud" has been demonstrated and as a result therefore, the appeals for all three parties for the years 1979 and 1980 are allowed including the penalties relative to the assessments for those years.

This leaves the balance of the years under appeal, 1981 through 1985, for review and with the exception of one amount which I shall deal with later, the issue is the same, the evidence is generally the same and the point addressed by the Court is the same as in the above, other than that the taxation years involved are not statute-barred. At this point I would note that the pleadings filed by the parties (including the amended pleadings) did deal with items which were no longer in dispute by the time of the trial—agreement had previously been reached between the parties. Information regarding those matters was not provided in detail at the trial, although I am sure it would have been available. This is important in the context of the balance of these reasons for judgment since it is at least possible that some of the missing connection between the areas of dispute in the trial (referenced later) might have shown up in the elements of these agreements between the parties. Those remaining issues revolved almost exclusively around the source of the disputed income amounts in the assessments. In these circumstances, a detailed accounting of the various years' discrepancies and the various amounts would serve little purpose. The issue brought to the Court as I see it, would remain essentially the same. For the record the original amounts (including penalties and interest) recited and challenged in the notices of appeal were:

*Due to adjustments, all the years covered by the “net worth" analysis did not result in reassessments.

The position of the respondent was stated in the reply to notice of appeal for Dick's Garage Ltd. (and in similar terms for the other two appellants in their respective replies to notices of appeal) as:

. . . the Minister of National Revenue computed the Appellant’s unreported income on the basis of a net worth analysis whereby the Minister of National Revenue calculated the increase in the assets of the Appellant's shareholders, John Dick and Beverly Dick, during the relevant period and assumed that any increase in the assets of John Dick and Beverly Dick not attributable to some other source represented unreported income of the appellant that was appropriated by John Dick and Beverly Dick.

I would refer again to the noted jurisprudence in Venne, supra, in which the learned justice reviewed the law so carefully and completely and I shall merely note one of the many similar phrases outlined in Venne, supra, from page 229 (D.T.C. 6252) : "For the taxation year 1973 the total income reported by the taxpayer was $8,594. He now admits that there was further unreported income in the amount of $49,391 for that year." [Emphasis added.] My difficulty in this matter is that there is no such admission of "unreported income" by the appellants, in fact there is consistent rejection by them that the disputed amounts came from the source identified by the respondent—Dick's Garage or from any other source as income. At the same time, there is no direct connection—and only rather vague indirect assumptions and assertions made in the respondent's evidence which would provide a relationship between the amounts in dispute and Dick's Garage. There is no question that there were amounts expended for assets—buildings, equipment, etc. which do not seem to have had their origin in the known and reported funds of Dick's Garage, and also there could have been bank deposits, and other cash expenditures falling into the same category. The amounts of these differences are generally not contested by the appellants, only the source of the funds. The appellants asserted (according to their testimony) that the funds came from a strongbox kept underneath a stairway, into which for many years John Dick placed the money sent or brought by his parents—for safekeeping. He contended that for many years—prior to 1979—he merely accumulated, but did not spend these funds because he wanted to prove he could get his garage business going without using financial aid from his parents. He was satisfied that he had done so by 1979. All the appropriate questions were asked of John Dick by counsel for the respondent in a detailed and professional cross-examination, and I readily admit that John Dick's answers were less than complete and reassuring to me. However, it is a moot point how complete these answers could be after the passage of many many years in the circumstances of this case. It is difficult to imagine that he would retain in a secret strongbox the substantial amounts of money at issue, knowing there was no interest being earned; that earlier in the 1970s he could have made profitable use of the funds to expand his business; and that the funds were to some degree at risk from loss, theft, or even fire "under the stairs”. But in the heady banking and financing days of the 1970s and 1980s, I doubt that it is the duty of this Court to prescribe for a taxpayer the manner in which he should have been required to keep funds in safekeeping.

I leave aside for the moment the subsidiary question of the penalties imposed, and the respondent's "burden of proof" under subsection 163(3) of the Act. Again I note that there is no linkage between the "net worth" analysis provided in support of the assessment of tax, and the alleged source of income—Dick's Garage. Neither was there any documented challenge made to the general statements of the appellants' accountant, supra, that income had been properly reported from Dick's Garage.

I am aware that certain jurisprudence, including some I have authored, dealing with the assessment results of "net worth" analyses would indicate that it is within the prerogative of the respondent to simply prepare just such analyses and summaries of the alleged discrepancies, ana then leave it to the appellants to destroy the assumption that the discrepancies arose out of a certain designated "source of income". Where no other possible source of income can be documented by the appellants and there is little other than vague “black box” source to account for the discrepancies, the result often seems to be a foregone conclusion against the appellants. In these instant appeals there was some evidence provided by the appellants—limited, old and possibly open to several interpretations, but evidence nevertheless. This consisted of bank records, from or originating in Germany, some fund transfer records of the same nature, some indication of dates of visits from Germany to Canada by the parents of John Dick, some letters and other correspondence touching on the subject of gifts and transfers of funds, and the direct testimony in Court of the sister of John Dick who did indicate she had received some funds and the proceeds from the sale of certain real property from her parents in Germany. It would be a difficult task to reconstruct from that testimony and evidence that amounts of money equal to these discrepancies were transferred to the control of John Dick—but the possibility cannot be ignored and the appellants' evidence treated as totally unacceptable. I make no attempt to put that evidence at some high level of credibility but it does add to my concerns about the opposing evidence from the respondent, as simply a "net worth" analysis with no direct connection whatsoever to the alleged "source of income" asserted by the respondent. This case comes down to one in which the respondent has rejected—and with understandable reason at the assessment level—the explanations advanced by the appellants that the disputed funds came from gifts, bequests, etc. from Germany, and the respondent has settled on what would appear to be the more likely source—the business operation of the individuals concerned—Dick's Garage. I would add that some of the information, evidence and testimony on behalf of the appellants which was made available at the trial, did not appear to me to have been readily accessible to the respondent before the trial. I have been provided with little reason to reject both the straightforward statements of the appellants and their accountant that income from the garage and dealership operation— Dick's Garage—was all accounted for in an acceptable way (except for the one instance of a $100,000 term deposit to which I shall return), and the proof that some funds were received from Germany, evidence which challenges a basic assumption of the respondent, that the disputed amounts should be attributed to the garage operation as the source. The respondent is treating the amounts arising out of the “net worth" analysis in this case as "income from a source" presumably as required and described in sections 3 and 4 of the Act. Current case law does not impose on the respondent the responsibility to demonstrate a direct connection between the discrepancies shown by a net worth analysis and the source of the funds alleged by virtue of the assessment or the pleadings, much as it would be useful here. In the absence of such a requirement I am prepared to accept as determinative the testimony and documentation of the appellants regarding the source of funds as an adequate answer to the question of the origin of the funds raised by the net worth analysis. The appeals for the years 1981 through 1985 will be allowed.

A "net worth” assessment is at best only an approximation, it may also be a frustration for all concerned. It is virtually a “last resort" method available in dealing with complex, poorly documented or highly contested financial situations. The task facing a taxpayer in dealing with any assessment of the respondent is challenging enough—the onus of proof is on that taxpayer. But in a “net worth" assessment where there is a clear conflict between the parties regarding the source of discrepancies, then a major factor in the determination of the issue might be any substantiation provided by the respective parties in support of each of the alternative "sources".

I should like to note two recent cases from this Court, which appear to cast some light on the question—Sara Shlien v. M.N.R., [1988] 1 C.T.C. 2244; 88 D.T.C. 1152 and Hayat Seifeddine v. M.N.R., [1988] 1 C.T.C. 2405; 88 D.T.C. 1269. I shall restrict the quotations to only two from pages 2248 and 2249 (D.T.C. 1155) of Shlien, supra, which represent my concern and reservations properly:

As I said before whether or not I accept the appellant's evidence as to her source of capital, and I am not prepared to reject it, I am satisfied that she has met the challenge that was incumbent upon her regarding the validity of the assessment under appeal. . . .

Admittedly the respondent is vested with wide powers under the Act but none that allows him to convert capital into income. His right to determine a taxpayer's income for a taxation year on the basis of a net worth analysis cannot be denied, but the exercise of such a determination must he in compliance with the provisions of the Act and in accordance with the principles laid out in the jurisprudence. To issue an assessment knowingly which does not meet this test amounts to abusing the application of the pronouncement of the Supreme Court of Canada referred to above that the onus of challenging the validity of an assessment rests with the appellant.

I would also adopt the reasoning provided in Markakis, D. v. M.N.R., [1986] 1 C.T.C. 2318; 86 D.T.C. 1237, recognizing that the circumstances under which the learned judge therein allowed the appeal, seriously questioned the respondent's position noted on page 2323 (D.T.C. 1241) thereof: "The Minister refused to acknowledge the existence of the loans between Mr. Markakis and his brothers, his uncle and his brother-in-law because in his view there was no evidence of the loans.”

I now return to the one major exception in which the situation from 1981 through 1985 is not covered by that conclusion. The respondent alleged that an amount of $100,000 for which a term deposit was held in the bank in the names of John Dick and Beverly Dick came from the sale of automobiles to a dealer in Winnipeg, Manitoba, and was not properly recorded as income to Dick's Garage. As well as I can understand the totality of the evidence adduced, this amount arose out of these sales, and that the portion which applied to the 1980 fiscal year was properly recorded and reported in Dick's Garage, even though the funds received by Dick's Garage were used directly as part of the payment for the $100,000 term deposit at issue. Counsel for the appellants contended that only the amount of $73,956.62 for 1981 was not properly recorded in the accounts, and that the taxpayers agreed to this amount being added to the income of Dick's Garage—albeit with the provision that it was just an error- determinable by a review of the banking records of all three appellants. In fact, the "error" seems to have come to the attention of the appellants' accountant in a routine bank confirmation procedure, which the accountant believes he adjusted and corrected in a year subsequent to 1981—as income to Dick's Garage—both as to the principal itself and the interest thereon. The situation is further complicated by the investment practice of the three appellants—to generally keep their deposits in the names of John Dick and Beverly Dick even though certain funds might have belonged to Dick's Garage—to which company it would appear interest earned was often credited. Further, at some periods of time John Dick was required by his bank to keep as security for financing, substantial amounts of term deposits—whether in the personal names or that of Dick's Garage. All in all, neither a very clear nor a very satisfying explanation was provided for the errant bank term deposit, either as to source, routine, accounting or ultimate resting place. In the end analysis, I am prepared to find that Dick's Garage's failure to report and account for the amount of $73,956.62, as acknowledged by the appellants, was not merely the result of some small oversight, or carelessness—it was the outcome of at least gross negligence on the part of the corporation, acting through its officers. Not only should that amount be assessed to income of the corporation for the year 1981, penalties and interest as appropriate should be imposed. If indeed, the amount was brought into income in years subsequent to 1981, as asserted by the appellants’ accountant, that is a point to be addressed by Revenue Canada in the reassessments which will result from this decision. However, I am not prepared to agree that there was any appropriation of this amount by the appellants, nor on the part of the appellants personally in taking out the term deposit in their own names. They should be given the benefit of the doubt in view of the fact that this practice seems to have been a usual business one.

The appeals of John Dick and Beverly Dick together with all penalties and interest for all the years 1979 through 1985 are allowed. The appeals of Dick's Garage Ltd. together with all penalties and interest for the years 1979, 1980, 1982, 1983, 1984 and 1985 are allowed. The appeal of Dick's Garage Ltd. for the year 1981 together with penalties and interest is allowed with the exception of an amount of $73,956.62 which is to be dismissed and remain as an addition to reported income of that corporation including relevant penalties and interest. The appellants are entitled to a total of one set of party-and-party costs.

Appeal in the main allowed.