L. John Chopp and Doreen B.A. Chopp v. Minister of National Revenue, [1987] 2 CTC 2071, 87 DTC 374

Christie, A.CJ.T.C.:—The appellants are husband and wife. Both were reassessed based on statements of net worth prepared under the authority of subsection 152(7) of the Income Tax Act ("the Act").* [1] The business involved was painting and sandblasting. The year under appeal by Doreen Chopp is 1979. The years under appeal by John Chopp are 1980 and 1981. With respect to Doreen Chopp both tax and penalties are involved. In the case of John Chopp only penalties are involved, there having been nil reassessments regarding his liability to tax. Although these appeals were heard on common evidence, these reasons will deal with and dispose of each appeal separately.

While at one stage of the hearing it was not clear whether John Chopp was seeking to appeal the nil reassessments, it was subsequently made certain that he was not. Even if he were, there would be no jurisdiction in this Court to entertain it. The law is settled that an appeal does not lie in respect of reassessments of that kind. The latest reported binding judicial pronouncement in this regard of which I am aware is that of the Federal Court of Appeal in The Queen v. The Consumers' Gas Company Ltd., [1987] 1 C.T.C. 79 at 84; 87 D.T.C. 5008 at 5012.

Regarding John Chopp's 1980 and 1981 taxation years the respondent alleges that he understated his income for his 1980 taxation year by $8,809.16 and by $35,321.03 for his 1981 taxation year and assessed $387.98 and $777.83 respectively by way of penalties under subsection 163(2) of the Act. It and subsections 163(2.1) and 163(3) provide:

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 regulation, is liable to a penalty of

(a) 25% of the amount, if any, by which

(i) the amount, if any, by which

(A) the tax for the year that would be payable by him under this Act

exceeds

(B) the amount that would be deemed by subsection 120(2) to have been paid on account of his tax for the year

if his taxable income for the year were computed by adding to the taxable income reported by him in his return for the year that portion of his understatement of income for the year that is reasonably attributable to the false statement or omission

exceeds

(ii) the amount, if any, by which

(A) the tax for the year that would have been payable by him under this Act

exceeds

(B) the amount that would have been deemed by subsection 120(2) to have been paid on account of his tax for the year

had his tax payable for the year been assessed on the basis of the information provided in his return for the year, and

(b) 25% of the amount, if any, by which

(i) the amount that would be deemed by subsection 122.2(1) to be paid for the year by him or his spouse, as the case may be, if that amount were calculated by reference to the information provided in the form

exceeds

(ii) the amount that is deemed by subsection 122.2(1) to be paid for the year by him or his spouse, as the case may be.

(2.1) For the purposes of subsection (2), the taxable income reported by a person in his return for a taxation year shall be deemed not to be less than nil and the "understatement of income for a year" of a person means the aggregate of

(a) the amount, if any, by which

(i) the aggregate of amounts that were not reported by him in his return and that were required to be included in computing his income for the year

exceeds

(ii) the aggregate of such of the amounts deductible by him in computing his income for the year under the provisions of this Act as were wholly applicable to the amounts referred to in subparagraph (i) and were not deducted by him in computing his income for the year reported by him in his return,

(b) the amount, if any, by which

(i) the aggregate of amounts deducted by him in computing his income for the year reported by him in his return

exceeds

(ii) the aggregate of such of the amounts referred to in subparagraph (i) as were deductible by him in computing his income for the year in accordance with the provisions of this Act, and

(c) the amount, if any, by which

(i) the aggregate of amounts deducted by him (otherwise than by virtue of section 111) from his income for the purpose of computing his taxable income for the year reported by him in his return

exceeds

(ii) the aggregate of amounts deductible by him (otherwise than by virtue of section 111) from his income for the purpose of computing his taxable income for the year in accordance with the provisions of this Act.

(3) Where, in any appeal under this Act, any penalty assessed by the Minister under this section is in issue, the burden of establishing the facts justifying the assessment of the penalty is on the Minister.

The only issue in this appeal being liability to penalties, the onus throughout is on the respondent under subsection 163(3) to establish on a balance of probabilities the facts justifying the assessment of the penalties.

My initial reaction at the hearing was that penalties could not be levied in respect of taxation years where the reassessments are nil regarding tax payable because of a misconception that penalties under subsection 163(2) were invariably 25 per cent of an amount related to actual tax payable. On reflection I am satisfied that penalties of the kind mentioned can be assessed even if no tax is payable in a taxation year provided, of course, that the essential requirements of subsection 163(2) are met. This rule is understandable. For obvious reasons Parliament desires that, in the preparation of their self-assessments under section 150 of the Act, taxpayers shall not knowingly or in a grossly negligent manner be involved in the making of false statements or omissions. Conduct of this kind attracts penalties per se notwithstanding that there is no liability for tax in a particular taxation year because, for example, losses are carried over from another year.

The initial basic step in cases of this kind is to determine the alleged understatement of income in respect of a taxation year in accordance with subsection 163(2.1). Under this subsection reported taxable income is deemed not to be less than nil and understated income is the aggregate of these amounts. First, the amount described in paragraph 163(2.1)(a), that is the amount by which the alleged unreported income that was required to be included in computing income for a taxation year exceeds the amounts deductible but not deducted by the taxpayer in computing his income for that year in relation to the unreported income. In this case, as the $8,809.16 in unreported income in 1980 is arrived at by a net worth reassessment there are no such amounts deductible so the $8,809.16 stands. Second, there is to be added the amount described in paragraph 163(2.1)(b), it being the amount by which the reported amounts deducted by the taxpayer in computing his income for a taxation year exceeds the amounts that were deductible by him in computing his income for that year. The appellant deducted $142.34 for Canada Pension Plan contributions in 1980. The increase in income increases the earnings subject to Canada Pension Plan contributions to an amount in excess of the 1980 maximum of $424.80. This amount is deductible. When $142.34 is subtracted from $424.80, the result is a negative remainder of $282.46 that when added to the $8,809.16 reduces it to $8,526.70. Mathematically: 142.34 - 424.80 —282.46 + 8,809.16 =

8,526.70. Third, there is to be added to the $8,526.70 the amount described in paragraph 163(2.1)(c), it being the amount by which the reported amounts deducted by the taxpayer (excluding loss carryovers) from his income for the purpose of computing his taxable income for a taxation year, i.e. Division C deductions, exceeds the amounts that were deductible by him (except loss carryovers) from his income in computing his taxable income for that year. The reported amounts so deducted by the appellant total $4,272.29 and there is nothing in evidence indicating that this amount is other than the amount that was deductible by the appellant in computing his taxable income for 1980. It follows that there is nothing to add to the $8,526.70 under paragraph 163(2.1)(c). Consequently the appellant's alleged understatement of income for 1980 as calculated under subsection 163(2.1) is $8,526.70.

The next basic step in calculating the penalty for 1980 is to apply the alleged $8,526.70 in understated income to subsection 163(2). In doing so clauses 163(2)(a)(i)(B) and 163(2)(a)(ii)(B) can be ignored because subsection 120(2) referred to therein only applies to income earned in Quebec and this appeal relates to income earned in Alberta. Paragraph 163(2)(b) relates to indexed child tax credits. It also has no application for present purpose. What remains of subsection 163(2) gives rise to an alleged liability to a penalty of 25 per cent of a number calculated in this way. First is determined the tax for 1980 that would be payable by the appellant if his taxable income for that year were computed by adding to the taxable income reported by him in his 1980 return that portion of his understated income for the year that is reasonably attributable to a false statement or omission in his return. The taxable income reported, as amended, was $1,622. If the appellant's alleged understatement of income is attributable to a false statement or omission, it is attributable to the entire $8,526.70. The sum of $1,622 and $8,526.70 is $10,148.70. The tax payable by the appellant for 1980 on $10,148.70 would be $1,551.93. From the $1,551.93 is subtracted the tax that would have been assessed on the basis of reported taxable income of $1,662. That is zero. Therefore the penalty is 25 per cent of $1,551.93. This is $387.98.

In 1981 the same fundamental approach was followed in arriving at the penalty of $777.83 subject to these variations. The appellant reported taxable income in a negative amount. In this regard, however, it must be borne in mind that, as already mentioned, under the opening words of subsection 163(2.1) his reported taxable income is deemed to be not less than nil. There is no adjustment for Canada Pension Plan or any other adjustment required for 1981 in respect of paragraph 163(2.1)(b). Again the figure in relation to paragraph 163(2.1)(c) is zero. Also with respect to the $35,321.03 of understated income for 1981 calculated by the respondent under subsection 163(2.1), only $17,879.13 is alleged to be reasonably attributable to a false statement or omission. The tax payable by the appellant in 1981 on taxable income of $17,879.13 is $3,111.32. Twenty-five per cent of $3,111.32 is $777.83.

Inter alia, subsection 163(2) makes it necessary to the determination of the penalties payable by the appellant in respect of his 1980 and 1981 taxation years that the respondent affirmatively establish the amount of understated income in each year. There is reported authority with which I will deal in a moment that shows the underlying difficulties in doing this on the basis of net worth reassessments in the absence of admissions by the appellant under cross-examination or otherwise, of which there are none in this case. On February 4, 1987, I delivered reasons for judgment from the bench in the case of Zakhem and Zakhem v. M.N.R. This appeal was heard in Ottawa and the reasons are not reported. Among other things I said:

Turning now to the penalties imposed under subsection 163(2). There is a recent judgment of this Court in this regard delivered by Judge Rip. I am referring to Fortis et al. v. M.N.R., [1986] 2 C.T.C. 2378; 86 D.T.C. 1795. I believe I should follow and apply this decision unless and until it is set aside by the Federal Court. I understand that it has been appealed. Fortis involved assessing penalties based on net worth reassessments.* [2]

In Fortis, Rip, T.C.J. said at pages 2384-86 (D.T.C. 1800-1):

In assessing a penalty under subsection 163(2) the Minister has to determine the amount of income the taxpayer failed to report and establish the circumstances surrounding the unreported income. The Minister must show a taxpayer has failed to report income so the Court can determine whether any particular penalty was in an amount authorized by subsection 163(2). See Elchuk v. M.N.R., [1970] C.T.C. 326 at 329; 70 D.T.C. 6234 at 6237.

Where a penalty is assessed under subsection 163(2) as a result of a net worth assessment it is frequently difficult for the Minister to establish facts justifying the assessment of the penalty. What is frequently described as a net worth assessment is a result of the Minister's estimate of the taxpayer's income based upon the best available evidence. See Dezura v. M.N.R., [1947] C.T.C. 375 at 377-80; 3 D.T.C. 1101 at 1102-4, per Thorson, P., Commercial Hotel Limited v. M.N.R., [1948] C.T.C. 7 at 8-9; 3 D.T.C. 1119 at 1119-20, per O'Connor, J. and Graham v. M.N.R., [1959] C.T.C. 514 at 519; 59 D.T.C. 1271 at 1274, per Dumoulin, J.

A taxpayer who disagrees with a net worth assessment may appeal the assessment but, notwithstanding the assessed tax may have been calculated on estimated income, the taxpayer still has the onus of demolishing the basic fact on which the taxation rested. See Johnston v. M.N.R., [1948] S.C.R. 486; [1948] C.T.C. 195 and Chernenkoff v. M.N.R., (supra). If the taxpayer fails in his onus to rebut the net worth assessment, the assessment remains in force. This is the result of the appellants' appeals from assessments of tax.

The question then raised is whether the Court may accept without any other evidence, the income determined by the Minister in making a net worth assessment as an indication of a taxpayer's understatement of income for the year for the purposes of subsection 163(2). In her submissions the appellants were grossly negligent in not reporting all their incomes, counsel for the respondent referred the Court to the decisions of Sam v. The Queen, [1974] C.T.C. 634; 74 D.T.C. 6493 (F.C.C.), Gadway v. M.N.R., [1984] 2648; 84 D.T.C. 1559 (T.C.C.), and Coscarella v. M.N.R., [1984] C.T.C. 3067; 85 D.T.C. 3 (T.C.C.), where the amounts of income calculated by the Minister were used in determining the penalty. Mr. Justice Kerr found that the Minister satisfied the burden of establishing the facts justifying the assessment of penalties against Mr. Sam, although his reasons for judgment do not discuss the evidence. Cardin, T.C.J. found sufficient evidence existed to support the penalties in Gadway (supra) and Coscarella (supra).

Subsection 163(3) imposes on the Minister the onus of establishing the facts justifying the assessment of the penalty under subsections 163(1) or (2). The onus on the Minister in respect of the penalty should be no different from the onus placed on a taxpayer who appeals from an assessment of tax. Consequently when a taxpayer appeals an assessment of the penalty, the Minister must establish on a balance of probabilities the facts justifying the assessment. A fact which must be established is the understatement of an income for the year since the amount of additional tax on which the penalty is calculated can only be determined once the understatement of income for the year is known.

Mr. Justice Rand described the onus of a taxpayer in an appeal from a taxation on income in Johnston v. M.N.R., (supra), at 489 (C.T.C. 202):

. . . since the taxation is on the basis of certain facts and certain provisions of law either those facts or the application of the law is challenged. Every such fact found or assumed by the assessor or the Minister must then be accepted as it was dealt with by those persons . . . the onus was [the taxpayer's] to demolish the basic fact on which the taxation rested.

In an appeal from an assessment of a penalty under subsections 163(1) and (2), however, any fact found or assumed by the assessor or the Minister cannot be accepted as it was dealt with by those persons since as a result of the coming into force of subsection 163(3) the Minister has statutory burden of establishing the facts justifying the assessment of the penalty. The Minister now cannot rely on assumptions pleaded in his reply to the notice of appeal to establish any fact justifying the assessment of the penalty. Neither Johnston nor M.N.R. v. Pillsbury Holdings Limited, [1964] C.T.C. 294; 64 D.T.C. 5184 is of assistance to the Minister in respect of a penalty assessed under subsections 163(1) and (2).

To permit the Minister to use his own arbitrary determination of understatement of income for the year based on a net worth assessment places the onus on the taxpayer to demolish the fact on which the penalty rested: this, as already stated, is contrary to subsection 163(3) of the Act. In The Queen v. W. Taylor, [1984] C.T.C. 436; 84 D.T.C. 6459, Mr. Justice Rouleau held, at 440 (D.T.C. 6463), that a finding under subsections 163(2) and (3) could not have been intended by Parliament to eliminate the duty imposed on the taxpayer under section 152 to prove the assessment of tax was wrong. Similarly, Parliament could not have intended that the facts relied on or assumed by the Minister in making an assessment under section 152 to eliminate the duty imposed on the Minister under subsection 163(3); otherwise subsection 163(3) would be rendered impotent.

The amount of the understatement of income for the year must be known prior to the penalty being assessed and the Minister must establish to the Court the precise quantum of the understatement of income for the year. As stated earlier, the Court cannot determine whether the penalty was in an amount authorized by subsection 163(2) unless the Minister first shows the taxpayer failed to report income and what that unreported income was. (Elchuk v. M.N.R., supra.)

It is not inconceivable, therefore, that the Minister may reassess tax pursuant to subsection 152(4) of the Act by adding to income reported by the taxpayer an amount the Minister estimates the taxpayer understated in his return of income, but may not succeed in assessing a penalty in respect of the same amount. See The Queen v. W. Taylor, (supra).

Once the Minister establishes the amount of understatement of income the taxpayer failed to report for the year, he may establish a false statement or omission was made by the taxpayer in his return with his knowledge or under circumstances amounting to gross negligence.

In the case at bar, the Minister assessed each individual appellant on a net worth basis and taxed the corporate appellant on the basis that the increases in income of the individual appellants and another shareholder of the corporation over that reported in their income tax returns represented unreported income to the corporation, their employer and sole source of income. No appellant succeeded in destroying the facts on which his assessments rested.

No evidence was led by the Minister to establish any fact justifying the assessment of penalties. The unreported income determined by Mr. Dykstra for each appellant was only an estimate, at best.

Applying this reasoning to the appeal of John Chopp I conclude that he is entitled to succeed. His appeal is therefore allowed and the matter is referred back to the respondent for reconsideration and reassessment on the basis that he is not liable to penalties under subsection 163(2) of the Act in respect of his 1980 and 1981 taxation years. He is entitled to party and party costs if he has incurred any.

Turning now to the appeal of Doreen Chopp, she is entitled to succeed on her appeal regarding the penalty assessed in relation to her 1979 taxation year under subsection 163(2) for the same reasons just given in respect of her husband's appeal.

On the other hand the onus is on her to establish that the respondent erred in his reassessment respecting her liability to tax. In Chernenkoff v. M.N.R., [1949] C.T.C. 369; 49 D.T.C. 680, which involved a net worth assessment, Mr. Justice Cameron of the Exchequer Court said at 375 (D.T.C. 683): "There can be no question that the onus lies on the appellant and that, in my view, means that she must establish affirmatively that her taxable income was not that for each of the years for which she was assessed." He went on to say that two courses were open to the appellant: first to establish her income with evidence showing proper deductions and allowances; second, in the absence of records, to prove that even on a proper net worth basis the assessments were wrong. These observations by Cameron, J. have been cited with approval by others. See, for example, Elchuk v. M.N.R., [1970] C.T.C. 326; 70 D.T.C. 6235, and Lorentz v. M.N.R., [1979] C.T.C. 2044 at 2046; 79 D.T.C. 83 at 86.

The appellant did not testify at the hearing, choosing to rely on her husband's testimony based on his personal knowledge of her business affairs. His evidence does not comply with either of the approaches described by Mr. Justice Cameron. Indeed the relevance of a good deal of it is not at all apparent. The evidence of Lesley Anne Zimmerman and Bridget Owerko, auditors employed by Revenue Canada, who testified on behalf of the respondent was not impaired under cross-examination. This aspect of the appeal fails. In the result the appeal of Doreen Chopp is allowed and the matter is referred back to the respondent for reconsideration and reassessment on the basis that she is not liable to a penalty under subsection 163(2) of the Act in respect of her 1979 taxation year. She is entitled to no other relief. I make no order regarding costs.

Appeals allowed in part.