Leeds Manufacturing Co v. Minister of National Revenue, [1985] 2 CTC 2284, 85 DTC 591

Tremblay, TCJ [TRANSLATION];—This appeal was heard at Montreal, Quebec on common evidence with the appeal of Harry Abelson (82-350) on April 11, 12 and 13, 1984. Verbal arguments were submitted on July 20 and August 23, 1984.

1. The Point at Issue

According to the originating proceedings, the question is whether the appellant Leeds Manufacturing Co (hereinafter referred to as "Leeds"), a corporation engaged in the textile business during the years at issue, was correct in claiming the sum of $935,690.19 as purchase costs during 1967-75. The respondent disallowed the costs of $935,690.19, alleging that these were fictitious purchases.

The respondent further maintained that Leeds failed to report the sum of $120,128.07 in sales made between 1972 and 1975. Finally, as a consequence of the changes in the taxable income for 1972-75, the cumulative deductions account was changed, affecting the small business deductions for 1976 and 1977.

Leeds disputed principally the respondent's refusal to allow it to deduct certain expenses incurred by it in earning income.

2. Burden of Proof

2.01 The appellant has the burden of showing that the respondent's assessments are incorrect. This burden of proof results not from a particular section of the Income Tax Act, SC 1970-71-72, c 63, as amended, but from several judicial decisions, including a judgment of the Supreme Court of Canada in Johnston v MNR, [1948] CTC 195; 3 DTC 1182.

2.02 In the same judgment, the Court held that the facts assumed by the respondent as a basis for assessments or reassessments are also presumed to be true until the contrary is shown. In the case at bar the facts presumed by the respondent are described in paragraph 5(a) to (h) of the reply to the notice of appeal, which is cited below.

3. The Facts

(A) Facts as stated in the originating proceedings

3.01 The facts stated in the notice of appeal are as follows:

1. In the years in question, the company was engaged in the textile business.

2. In assessments dated October 30, 1978, for 1967-77 inclusive, the respondent included in the company's income certain amounts described as fictitious purchases for 1967-75, and for allegedly unreported sales in 1972-75. For 1976 and 1977, the respondent adjusted the operating profit deduction.

3. The appellant admits certain amounts as fictitious purchases and unreported income, but disputes the respondent's refusal to allow it to deduct certain expenses incurred by the company in earning income.

4. For 1976 and 1977, the appellant met all the conditions set by section 125 of the Act for small business deductions and for operating profit.

5. The Minister’s assessments are incorrect in fact and in law.

3.02 In his reply to the notice of appeal, the respondent made certain admissions and stated the following facts:

(A) Statement of facts

1. He admits paragraph 1 of the notice of appeal.

2. He admits the facts alleged in paragraph 2 of the notice of appeal, except that the words “described as” in line four and the word “allegedly” in line five should be deleted.

3. He notes paragraph 3 of the notice of appeal, in particular the fact that the appellant admits the “fictitious purchases” and “unreported income”, and limits its opposition to the refusal to allow the deduction of “certain expenses”.

4. He denies paragraphs 4 and 5 of the notice of appeal.

5. In assessing the appellant for its 1967-77 taxation years the respondent relied, inter alia, on the following facts:

(a) the appellant claimed as operating costs for 1967-75 fictitious purchases totalling $935,690.19;

(b) these purchases are fictitious because the goods the cost of which the appellant claimed to deduct were not delivered;

(c) cheques covering the said fictitious invoices were issued to accommoda- tors, who paid the amounts of the cheques, less a 2 per cent commission, to Frances Long Weinstock, a director and vice-president of the appellant;

(d) the said Frances Long Weinstock paid the money to Harry Abelson, the principal shareholder and president of the appellant, on the instructions of the said Harry Abelson;

(e) a table giving an “annual summary of fictitious purchase invoices” is attached hereto, to be an integral part hereof;

(f) additionally, in 1972-75 the appellant failed to report sales totalling $120,128.07, as appears from the table ‘‘annual summary of unreported sales” attached hereto, to be an integral part hereof;

(g) the appellant alleged that subcontractors and employees were paid in cash between 1972 and 1975, and these expenses were not recorded in its books: after making an audit, the respondent allowed additional expenses of $277,896 distributed in the manner indicated on forms TCW-C accompanying the notices of assessment for 1972-75;

(h) the assessments made for 1976 and 1977 result from the fact that the appellant's taxable income was increased for 1972-75, the effect of which was to alter the “cumulative deductions account” and so to change the amount of the deductions allowed as small business deductions (s 125 of the Act) and as manufacturing and processing profit (s 125.1).

3.03 Arguments of the respondent

The respondent’s principal arguments were stated as follows in the reply to the notice of appeal.

7. He [the respondent] maintains that, as the appellant accepted in its notice of appeal the additions made to the calculation of its income for each of the years 1967-75, the only point at issue is the claim for “certain expenses”.

8. He maintains that the expenses allowed by the assessments for 1972-75 are the only ones which can be allowed and he submits that the appellant did not establish that it incurred ‘‘certain expenses” other than those it was allowed.

9. He maintains that the adjustments made to the calculation of the tax deductions available under ss 125 and 125.1 of the Act were correctly made.

10. The appeal is incorrect in fact and in law.

(B) Admissions and denials in Court

3.04 At the start of the evidence, it was admitted by Leeds that there would be no dispute regarding the $935,690.19 of fictitious purchase invoices alleged by the respondent in paragraph 5(a) of its reply to the notice of appeal. A similar admission was made regarding the sum of $120,128.27 in unreported sales, alleged in paragraph 5(f) of the reply to the notice of appeal (trans for 11-04-84, pp 6 and 7).

(C) Arguments of Leeds

3.04.2 Leeds argued that the system of fictitious invoices and unreported income simply allowed it to obtain cash. This was used first to pay Leeds employees for overtime, and second to pay contractors who hired people to work for Leeds and to pay people working at home. All these persons made dresses and other articles with sewing machines.

3.04.3 The respondent, for its part, did not deny that 1971, 1972 and 1973 are prescribed as to the appeal by Abelson (82-350), but argued that at the very least he misrepresented the facts within the meaning of subparagraph 152(4)(a)(i) of the Income Tax Act, and therefore that the reassessments made for these years are correct.

(D) Facts as established by testimony and exhibits

3.05 In his examination-in-chief Mr Abelson testified as follows (trans vol I, pp 45-47).

(a) Leeds was incorporated in 1939. He personally began working there in 1945 when he was discharged from the Canadian Air Force after the war. He became the 100 per cent majority [sic] shareholder in 1970-71 when he purchased the shares of his brother Percy for about $45,000, with money borrowed from the Royal Bank (Exhibit 1-17).

(b) Leeds makes ladies’ clothing.

(c) Sales were relatively modest until 1970. Between 1970 and 1977, however, they climbed from $400,000 to $1,600,000.

(d) In 1978, Leeds ceased its activities and sold its assets.

(e) Between 1971 and 1975 he owned the following businesses:

(f) Persons working at home and contractors working for Leeds insisted on being paid cash: "They'd say if you pay me cash, I put your work through. If not, we can’t put it through and this was the way we operated" (vol I, p 52).

Mr Abelson further stated that the same was true for employees who worked overtime: "They would not work unless they pay [sic] cash; this was their decision (vol I, p 156).

3.06 Leeds’ accounting systems to obtain cash

The evidence showed that, at least from 1967 to 1975, Leeds in addition to its ordinary accounting system, which could readily be audited, had a second system for the purpose of obtaining cash: one for fictitious purchase invoices and the other for unreported sales (trans vol I, Mr Abelson, pp 60 et seq; Mrs Weinstock pp 183 et seq).

3.07 System of fictitious purchase invoices

3.07.1 The appellants' evidence

Planning one month in advance, in accordance with the company's cash needs, the Leeds general manager, Mrs Weinstock (trans vol I, pp 184, 192 and 193) notified certain hand-picked persons to submit fictitious purchase invoices to Leeds. They were to be payable within thirty days. At the agreed time, the said persons or their representatives came to the Leeds office. Mrs Weinstock gave them a cheque for the amount of the invoice and the recipient gave Mrs Weinstock an amount of money equalling 94 per cent of the amount of the cheque. The supplier of the cash thus received a six per cent commission for his work. On receiving the money, Mrs Weinstock put it into a special carefully concealed safe. In calculating its income, Leeds claimed the amount paid by the cheque as expenses.

The fictitious purchase invoices so claimed as deductions from 1967-75 amounted to $1,213,586.55, according to the inquiry and the reassessments issued. This sum was initially disallowed as an expense, and the company’s income increased accordingly, for the period between 1967 and 1975. The respondent subsequently made an allowance for an amount of $277,896.36, which was apparently actually paid in wages, leaving a balance of $935,690.19.

Additionally, the fictitious purchases from 1971-75 amounting to $711,115.80 (included in the $1,213,586.55) and the unreported sales of $120,128.07 were used to increase the income of Mr Abelson, the Leeds shareholder. As the aforementioned sum of $277,896.36 was credited, additional income of only $613,887.87 had to be taxed as received by Mr Abelson. These figures appear in paragraph 4(f) of the reply to Mr Abelson’s notice of appeal, with other information on which the reassessments were based, as indicated below:

3.07.2 The respondent's evidence

The respondent arrived at the foregoing information regarding the fictitious purchases and additional expenses allowed following a lengthy inquiry.

First, the respondent discovered the fictitious purchases. He then told Leeds that he had evidence showing, first, a list of fictitious invoices for 1972 and 1975, totalling about $756,000. Going back to 1967, the auditor established a total of $1,026,159.12, allowing for the $277,896 credit from 1967-75. As the result of discounts and book adjustments, this amount was reduced to $935,690.19, as appears in Exhibit 1-23. This exhibit also gave a list of the companies involved in these transactions, with the appropriate amounts for each company and year.

To explain the expenses paid for with cash, the appellants in March 1978 supplied the respondent with the names of persons to whom the sum of $589,650 was paid in cash. An initial list [showed] 14 principal persons (contractors, workers and Mrs Weinstock) to whom Leeds estimated that it paid $324,235 in cash. Of this amount, the sum of $56,849 was accepted after auditing. A further list of 165 persons to whom Leeds paid $265,415 in cash was provided to the respondent. Of this amount the sum of $141,619 was accepted without audit, because of the number of persons and the relatively small amounts involved. A balance of $123,796 remained. Of this amount, the sum of $79,428.36 was accepted after auditing. Accordingly, of the total of $589,650 submitted, the sum of $277,896.36 was accepted (Exhibits I-24 and I-25).

Most of the persons whose names were given on the first list testified in court.

The auditor allowed and disallowed the amounts on which the assessments are based in reliance on the sworn statements and explanations provided by these persons (cross-examination of Mr F Taza, pp 123-149).

3.08 Unreported sales system (URS)

3.08.1 According to the appellants' evidence

The said system, which was also used to obtain cash, worked as follows, at least from 1972-75 (Mr Abelson, vol I, pp 61, 81, 88 and 161, Mrs Weinstock, vol I, pp 188 and 207).

Leeds sent a number of customers handwritten (or typed) invoices rather than official invoices prepared by computer. They were actual invoices but were not part of the official accounting system.

Additionally, according to Mr Abelson and Mrs Weinstock, the official accounting system issued a cheque to Mr Abelson on the same day for an amount equal to the invoice sent to the buyer. This amount was regarded by Leeds as a loan to Mr Abelson, who the same day went to the bank and cashed the cheque. According to his testimony, he gave this money to Mrs Weinstock, who placed it in the special safe mentioned above.

On receipt of the cheque issued by the customer, who had received the handwritten (or typed) invoice, Leeds cashed the cheque and treated the loan made to Mr Abelson as repaid.

3.08.2 According to the respondent's submission

According to the respondent's evidence, he was not told of the URS system described in the appellant’s evidence. It was discovered by him on examining bank deposits and withdrawals.

The system was not followed to the letter, as indicated by Mr Abelson and Mrs Weinstock. The cheque issued to Mr Abelson after the invoicing was not always on the date of the invoice. The cheque was also sometimes issued to Mrs Weinstock. Finally, recording a “loan” to Mr Abelson and “loan repayment" were rarely followed (Exhibit 1-13-21 — Mr Taza, vol Il, pp 24-120). The total sum for which the system described by the appellants was not followed was approximately $42,000.

Four companies were the source of unreported sales from 1972-75:

3.08.3 These actual sales were not included in calculating Leeds’ income when it filed its income tax return. The sales from 1972-75 totalled $120,218.07.

The respondent added this amount to the company’s income in making the reassessments of Leeds. The respondent also added the same amount of $120,128.27 for the same years, 1972-75, in calculating Mr Abelson’s income (see para 3.07.1 in fine).

3.09 Use of cash

3.09.1 The appellants’ evidence

According to the witnesses for the appellants, the cash obtained from the total of fictitious purchase invoices ($1,213,586.55) and from unreported sales ($120,128.27) was used in its entirety by Leeds to make payments in cash to:

(1) Leeds’ employees for overtime;

(2) persons working at home, at their residences, sewing pieces of material already cut out and so completing dresses or other items for sale;

(3) contractors who hired them and paid these homeworkers on behalf of Leeds.

The cash used to pay employees, workers and contractors was handled by Mrs Weinstock alone. If Mr Abelson had taken any, she would have known of it. No money was ever missing from the safe. The receipts and envelopes were initialed both by Mrs Weinstock and by her assistant Mrs Greenberg. The money was always used for the specified purposes (testimony of Mr Abelson, vol I, pp 64, 69, 70, 104, 105 and 164, Mrs Weinstock, vol I, pp 187 and 188).

In addition, in making his reassessments and based on his inquiry, the respondent allowed expenses of this kind for 1972-75 in the amount of $277,896 only.

The respondent also made allowance for this amount of $277,896 in calculating the amounts which he alleged Mr Abelson had appropriated (see paragraph 4(f) of the reply to the notice of appeal in Mr Abelson’s appeal; cited above at the end of para 3.07.1).

3.09.2 The respondent's evidence

3.09.2.1 Referring to the unreported sales system, the respondent summarized the following cheques which did not appear to have been used for cash payments.

1. A cheque of $3,714.67 dated July 9, 1973 to Harry Abelson (Exhibit 1-19) with the following endorsement: "USDF” (that is, US draft) $3,005.60, cash $709.06. On July 10, a US draft was issued to Taylor Marine (“Taylor Marine and Exporting Goods” was written on the back) in the amount of $3,000. This was a US sporting goods business. Referring to this cheque, counsel for the appellant told Mrs Weinstock "The amount seems like this money [sic] has been kept by Mr Abelson”. She said this did not happen often and went on to explain that when cash was missing, Mr Abelson made it up, but she could not say where he took it (trans vol IV, pp 24 and 25).

2. A cheque for $5,000 dated March 22,1975 (1-18), issued by Shoppers Bazaar Inc to Leeds, was deposited to Leeds' account on April 11, 1973. The following day, on April 12, 1973, a payment of $5,000 was made to Mr Abelson, to reduce his personal loan account. The account decreased from $43,000 to $38,000 (I-17). This was also the account which Mr Harry Abelson used to pay his brother Percy for the Leeds shares (see para 3.05(a)).

3. A cheque for $3,389.22 dated May 9, 1973 (I-18), issued to Leeds by Shoppers Bazaar Inc, was deposited on May 22, 1973 to Leeds' account. A payment of $3,000 the same day reduced the personal loan account (1-17), decreasing the balance from $38,000 to $35,000.

4. A cheque for $565 dated November 15, 1973 issued by Sweater Bazaar was cashed by Leeds the following November 27. A cheque in the same amount was issued by Leeds to Harry Abelson on the same day. The cheque was cashed on November 29. It was endorsed by Harry Abelson and S Abelson (Sari Abelson, Harry Abelson's wife). Below the latter's name is the number 3008. The evidence disclosed that this was the personal account of Sari Abelson (Exhibit 1-21, F Taza, trans vol II, pp 112 and 113).

5. A cheque for $2,256.48 issued by Plaza d'enfants Itée, dated August 27, 1973, was cashed by Leeds on August 31, 1973. A cheque in the same amount was issued to Harry Abelson on September 5, 1973. On the back of the cheque the following calculation appears: $2,256.48 - $2,028.28 = $228.20 (Exhibit I-21). In the personal loan account (I-17), it can be seen that the capital account was decreased on September 5, 1973 by $2,000 capital and $28.28 interest (Mr F Taza, N-5, vol Il, pp 114-118).

6. A cheque for $5,000 issued by Plaza d'enfants Itée on September 28, 1973 was cashed by Leeds the following October 1, On the same day a cheque for the same amount was issued by Leeds to Harry Abelson. On the back are the letters "T/C” below Mr Abelson's signature. The evidence disclosed that these letters, written by the cashier, meant "traveller's cheques” (Exhibit 1-21, Mr F Taza, trans vol Il, pp 114-118). No explanation was given concerning these traveller’s cheques.

3.09.2.2 Referring to the contractor system, the respondent took from Mr Abelson’s 1975 tax return the financial statement titled ““G Domingue Reg'd — Statement of operation [sic] for year ended February 28, 1975 and operated by H Abelson”. It appeared from this statement that gross income was $36,027.59, expenses $36,557.85 and net loss $530.26.

Additionally, Mr Abelson stated in his testimony that wages and rental for G Domingue Enr were paid with cash from Leeds. In the financial statement these items appear as follows:

The loss of $530.26 was claimed as a loss against Mr Abelson's personal income. The appellant appeared surprised that this financial statement was in his own tax return and that a loss was claimed. He even said he did not recognize his signature on the return.

The respondent filed the registration for this business, G Domingue Enr, dated April 1974, as Exhibit I-7. The business was in the name of Frances Weinstock. She allegedly operated it at 5737 rue Iberville, Montréal.

According to Mrs Weinstock, a business registered in the name of Georgette Domingue which was going bankrupt was bought by Leeds. It was registered in her name (Mrs Weinstock's) because of the Comité conjoint: . . mostly and production, to have another place for production for that if the Comité Conjoint caught them working, so the fine would not be as high because if it was Leeds caught again because Leeds was caught working overtime so many times . .(trans vol . . . pp 222 and 223).

3.09.2.3 The respondent filed as Exhibit 1-5 a voluntary statement dated September 5, 1976 made by Canadian Youth Products Ltd, in which Mr Abelson owned 50 per cent of the shares. This voluntary statement concerned fictitious purchase invoices of that company which had gross income of $47,415.76 in 1974 and $115,271.80 in 1975. The money received by shareholders was $43,679.30 in 1974 and $106,188.38 in 1975.

Following the inquiry the two shareholders admitted making appropriations for 1974, 1975 and 1976 totalling $163,182.60. Each shareholder repaid $81,591.30 to the company. This avoided their being taxed on these amounts. according to the agreement made with the respondent.

3.10 Secondary evidence by the appellants to establish that all cash was used to pay wages

In essence Mr Abelson and Mrs Weinstock testified that all the accumulated cash in the safe was used by degrees, and in its entirety, to pay the three groups of workers.

To confirm this testimony, the appellants called an expert witness, Mr Edward Shinder (trans vol II, pp 40-53).

The witness has been a chartered accountant since 1959. He is a member of the accounting firm Appeland Partners. Since 1961 he has handled the accounts for 50 to 75 clients in the garment industry.

Based on his experience in this type of industry, and in particular on information gathered from two companies (COB and COR), who were among his clients (see vol V, pp 54, 63 and 64), he made a comparison with the Leeds figures, figures taken from the reassessments. This indicated that for 1972-75, first the labour cost (LC) for Leeds was less than the average cost for the other two companies (COB and COR), and second, that as a result Leeds' profits were greater. This result is indicated as follows in Exhibit A-4.

Additionally, by adding to Leeds the amounts disallowed by the respondent as deductions for work paid in cash, the labour percentage is as follows (Exhibit A-5):

Average

COB and

	Leeds	COR	COR
1967	18%
1968	25%
1969	26%
1970	18%
1971	24%
1972	30%		30.68
1973	28%		35.61
1974	35%		35.50
1975	31%		35.33

In cross-examination the witness was unwilling to disclose the name of the two clients whose figures were used as a basis for his comparison. He also said he did not know whether these clients paid their employees with cash for overtime and had unreported sales.

Mr Shinder said in essence that an audit was done each year when the financial statements of the said companies were prepared, and that if there had been fictitious accounting entries he would have known of it, and would not have accepted these companies as clients.

3.11 Overtime

3.11.1 The appellants’ evidence

3.11.1.1 According to most of the witnesses heard, the Leeds employees did at least 20 hours' overtime a week, from January to June, and according to Mr Abelson were paid in cash. Some employees could even do 24 to 32 hours' overtime a week. The overtime was done between 4 pm and 9 pm. It was also sometimes done on Saturday mornings (trans Mr Abelson, vol I, p 58). In 1972-75, the number of employees at Leeds varied from 45 to 75 (trans vol I, p 72).

3.11.1.2 According to Mrs Weinstock, apart from the four or five office employees all the others did overtime. The moneys paid in cash by Leeds, in all forms, could sometimes be between $40,000 and $50,000 a month. Mrs Weinstock essentially confirmed Mr Abelson’s testimony regarding the number of hours of overtime.

3.11.1.3 Mr Jules Sziloggi, who has been in charge of shipping for Leeds since 1965, said that he worked about 20 hours' overtime a week between January and June.

In cross-examination, he said that from 1967 to 1975 he was paid in cash. He knew that the other employees of other departments also did overtime and were also paid in cash (trans vol Il, pp 4 and 7).

3.11.1.4 Michel Tessier, a deliveryman and truck driver for Leeds for five years (1973-78), testified that he took supplies to contractors and to persons working at home. He paid for work done and took the finished clothing back to Leeds. Until 1976 (that is, until the respondent's inquiry), payments were made partly in cash and partly by cheque.

He testified that he did from 20 to 25 hours' overtime a week, and that until 1976 he was paid in cash (trans vol II, pp 71 and 76).

3.11.1.5 Mrs Ladéroute (trans vol I, p 172), who worked in accounting, said that sometimes there was even so much overtime that the amounts paid in cash were greater than the employees' regular pay.

According to this witness, the overtime was not included in the T-4 forms issued by Leeds (trans vol I, p 138).

3.11.2 The respondent’s evidence

The respondent's evidence on overtime was that there was never any suggestion by the appellants during the inquiry that cash was paid to Leeds employees for overtime during 1972-75 and even earlier.

In short, it was not until the case was heard in April 1984 that the appellants brought this new fact to the respondent's notice. Needless to say, therefore, no amount was allowed for this item in making the reassessments.

3.12 Persons working at home

With specific reference to persons working at home, Mr Abelson stated that in 1971-75 there were at least 300 different persons who worked for Leeds.

Between 50 and 100 worked for Leeds regularly (trans vol I, 50 and 59). These persons were paid in cash in an envelope. They counted the money and signed the envelope. The envelopes were returned to Leeds by the deliveryman (trans Mr Abelson, vol I, p 52, Mrs Ladéroute, vol I, pp 167 and 177, Stephen Weinstock, vol II, p 10).

3.13 Contractors

About five to seven contractors worked for Leeds during the period from 1971 to 1975 (Abelson vol I, p 55). Some were paid only in cash and others by cheque and in cash.

Most of the contractors mentioned below worked through a company. Mrs Quadrini (a witness for the respondent) said she was paid cash. She signed the envelopes. Between 1971 and 1975 she said she received about $15,000 from Leeds through her own company.

Mrs Lepage (a witness for the respondent), who had up to ten employees, first said she was paid by cheque. Later, after seeing her statement signed in 1978 (Exhibit 1-27), she said she was paid in cash in 1970 and 1971. She said she received $5,000 (trans vol Il, pp 169-175).

Mr Gurman (a witness for the respondent) signed a statement in 1978 (Exhibit I-28) saying that he received cash. In 1974 and 1975, he said he received about $3,000 (vol II, pp 117 and 179).

Mr Ethier (a witness for the respondent) said he was paid about $10,263 in cash for 1973, 1974 and 1975 (Exhibit 1-20, trans vol III, p 42).

Mrs Boisjoli (a witness for the respondent) received cash. She said this was the Leeds policy. According to her statement (Exhibit I-31), in 1973 and 1974 she received about $10,000 (trans vol III, pp 69 and 70).

3.14 Destruction of incriminating documents

The documents used to establish where money came from (the envelopes bearing the signatures of representatives of the suppliers of fictitious invoices and the amount of cash) and the documents establishing use of the cash (envelopes and signatures of recipients, contractors and so on) were destroyed approximately every six weeks (trans Mr Abelson, vol I, p 97, Mrs Weinstock, vol I, p 205): “They were too incriminating/' Mr Harry Abelson said (trans vol I, p 104).

3.15 Mr Fred Taza, an income tax auditor for Revenue Canada in Montreal, questioned by counsel for the appellant, stated that the sum of $613,887 included in Mr Abelson’s income was not found among his assets (trans vol II, p 29). According to Exhibit A-3, financial statements (reconciliation and balance sheet) prepared by Mr Taza, the total income not reported by Mr Abelson amounted to $190,489.40. The capital reconciliation read as follows:

Mr Taza further testified that the sums of $795,000 from fictitious invoices and $120,000 from unreported income, all of which was included in Leeds' income, were not found in the company’s assets (vol II, p 33).

3.16 Why were payments made in cash?

There appear to be several reasons why payments were made in cash: first, the decision of the Comité conjoint to limit employees' regular working hours to 36 hours a week. Leeds had already been prosecuted on this matter. According to Mrs Weinstock, the employees wanted to be paid in cash — otherwise, they would not have worked.

3.17 Leeds' financial statements were based on an audit made by accountants, except for 1976.

4. Act — Case Law — Analysis

4.01 Act

The principal provisions of the Income Tax Act involved in the case at bar are 3,9, 163(2), 125 and 125.1. They will be cited in the analysis if necessary. 4.02 Case law

The case law referred to by the parties is as follows:

1. Roselawn Investments Ltd v MNR, [1980] CTC 2316; 80 DTC 1271;

2. RWS S Johnston v MNR, [1948] CTC 195; 3 DTC 1182;

3. Wolfgang Schubert v MNR, [1978] CTC 2033; 78 DTC 1039;

4. J Santarossa et al v MNR, [1978] CTC 2390; 78 DTC 1294;

5. § Berbynuk v The Queen, [1978] CTC 448; 78 DTC 6322;

6. Lodie Saykaly v MNR, [1976] CTC 702; 76 DTC 6440;

7. David Laurie Diller v MNR, [1980] CTC 2532; 80 DTC 1444;

8. Muller's Meats Limited v MNR, [1969] Tax ABC 171; 69 DTC 172;

9. Louis Farovitch v MNR, [1980] CTC 2594; 80 DTC 1494;

10. Monarch Metal Co Ltd and Bereskin v MNR, [1982] CTC 2417; 82 DTC 1398;

11. King Lee and Bic Lee v MNR, [1982] CTC 2621; 82 DTC 1638;

12. Antonio Zacconi v MNR, [1971] Tax ABC 737; 71 DTC 521;

13. Jean-Guy Papillon and Paul Papillon v MNR, [1980] CTC 2420; 80 DTC 1355;

14. Espie Printing Company Limited v MNR, [1960] CTC 145; 60 DTC 1087;

15. Moshe Schwarz v MNR, [1981] CTC 2147; 81 DTC 93;

16. Fernand Renaud v MNR, [1976] CTC 2233; 76 DTC 1179;

17. Léopold Baithazard v MNR (1959), 23 Tax ABC 200; 60 DTC 1;

18. No 684 v MNR (1959), 23 Tax ABC 321; 60 DTC 594.

4.03 Analysis

4.03.1 Several points are at issue in these two appeals:

(a) in calculating Leeds' income, should other expenses for the payment of wages in cash be allowed, pursuant to documents and the testimony given (para 4.03.2 and 4.03.4) and the expert testimony (para 4.03.3)?

(b) should the reassessments issued to Mr Abelson for the prescribed years 1971, 1972 and 1973 be invalidated (para 4.03.5)?

(c) should the amounts received in cash by Leeds, evidence of which was not allowed as wages paid for in cash, be regarded as appropriations by Mr Abelson (para 4.03.6)?

4.03.2 Should the taxation in Leeds' income of 935,690.19 (fictitious purchase invoices) from 1967-75 and $120,128.07 (unreported sales) be upheld? The sum of $277,896.36 has already been allowed as payments for under- the-counter work.

4.03.2.1 First, from the admissions made (para 3.04), there was no issue as to the quantum or source of this money. Additionally, according to the appellants these procedures were used to accumulate a cash fund.

The appellant’s evidence was that this cash was entirely used to pay for under-the-counter work (para 3.04.2 and 3.09.11), apart from the amount of $277,896.36 already allowed as a deduction for this purpose by the respondent. In view of the absence of supporting documentation — it was destroyed: “it was too incriminating” (para 3.14) — the lists of names supplied by the appellants (1-34 and 1-25), the amounts accepted after audit, the testimony given by the contractors and persons working at home, the Court cannot reasonably allow any more for amounts paid to persons working at home and contractors (see para 3.07.2, 3.12 and 3.13).

The lack of supporting documentation is due merely to the accounting system which was deliberately falsified by Leeds. It must, therefore, bear the consequences of its system.

4.03.2.2 As regards overtime, also paid for in cash, this was a last-minute fact, which the respondent was not told of until the evidence was presented in Court in the case at bar (para 3.11.2).

He was therefore unable to allow any expenses for this purpose in making the assessment. The explanation given by Mr Abelson was that he did not want to place his employees in a position where they would be required to pay tax: but what was the evidence presented?

Four Leeds employees testified that overtime was paid for in cash (para 3.11.1). Overtime was done from January to June, about 20 hours a week. The number of employees from 1972 to 1975 varied between 45 and 75 (para 3.11.1.1). Only the four or five office employees did no overtime. When Mrs Weinstock said that sometimes the amounts paid in cash might be as much as $40,000 to $50,000 a month, these sums were not limited to overtime (para 3.11.1.2) but also included contractors and persons working at home. There was no evidence to support this statement. Mrs Ladéroute (para 3.11.1.5) said that sometimes moneys paid as overtime exceeded the employees' regular pay. However, no evidence was presented of the amounts paid to employees, whether for regular working hours or for overtime.

Though the Court is prepared to admit that overtime was paid for in cash, how can these payments be quantified?

In Diller, [1980] CTC 2532 at 2534; [1980] DTC 1444 at 1446, losses resulting from foreign exchange were difficult to quantify for lack of evidence and not clearly applicable to the years at issue. The Court decided to disallow the expense.

Even though I have no doubt that there was an overall loss from the foreign exchange trading carried on by the partnership, I cannot say how much, if any, was available for application in the computation of taxable income for the years now under appeal.

The appeals must therefore be dismissed . . .

Before making a final decision as to the quantum, a ruling must be made on the “expert testimony” of Mr Shinder. If this evidence is accepted, the deduction allowed would include a deduction for the aforementioned point.

4.03.3 The appellant called as an expert witness Mr Edward Shinder, CA, who told the Court that between 1967 and 1975 all the cash received from the fictitious invoice and unreported sales system was spent for wages (para 3.10). The crux of this evidence was that the wages paid by Leeds for the years at issue were 5.59 to 14.94 per cent below those of the two companies which Mr Shinder took as a model. This lower expense, he said, was explained by the fact that wages were paid in cash, though the respondent refused to deduct them.

It is difficult at first sight, for several reasons, to accept the very basis of the comparison. Nothing is known of the two model companies: their names or the number of employees they had. Additionally, though the witness said that the nature of their business was the same, how can this be checked without being able to cross-examine? We do not know whether the two companies also paid their employees with cash and whether they had unreported expenses.

The evidence further did not show whether the said two companies were the subject of an audit by the respondent in 1976 and 1977, at the same time as the 200 other garment industries located in the Montreal area. A sample of two models or bases of comparison is not sufficiently representative. Mr Shinder stated that the said two companies were audited annually when the financial statements were prepared, and that if there had been any false accounting entries he would no longer have accepted them as clients. We have to take his word for this. However, Leeds also had financial statements which were audited for the years in question, except for 1975 (para 3.14). This audit did not prevent Mr Shinder from saying that he did not attach any credibility to the Leeds financial statements (trans vol IV, p 15).

Another important point, which could not be checked with the two model companies, was the wages paid to members of the executives of the said companies: in certain cases, this might affect the percentages given in the expert testimony. In order to be admitted as evidence, expert testimony of this type must meet a number of requirements which may vary from case to case. These requirements must be such that they establish the facts at issue as objectively as possible, making the basis for comparison almost an alter ego of the entity compared. Clearly, too, the number of items making up the comparison must be large enough that the latter will be really representative of the group as a whole (garment manufacturing industries in the case at bar), to which the entity compared belongs (Leeds in the case at bar).

The weight of the evidence in the instant case does not allow the Court to use the basic information and conclusions suggested by Mr Schinder. The sums of $935,000 and $120,000 cannot therefore be assumed to have been paid for wages.

In Espie Printing Co Ltd (para 4.02(14)), in which evidence of the same type was presented, though the problem was primarily the difference in profit margins between other businesses similar to that of the taxpayer, Thurlow, P made the following comments, which apply mutatis mutandis to the case at bar (CTC 151; DTC 1091):

It was brought out in cross-examination, however, and indeed it is obvious, that the ratio of profit to gross revenue could vary considerably for a variety of reasons, such as whether the plant was new or old, the amount of expenses incurred for executive salaries, and for pension and fringe benefits to employees, the efficiency of the management, and the volume of work done, and it appears as well that the companies from which information was obtained and used in computing the average for the industry included some whose businesses were not of the same type as that of the appellant’s business. A considerable discount must, accordingly, first be applied in comparing the average with the results of the appellant's operation. Secondly, it is apparent that, if the Minister has included too much gross revenue, as I have found, with respect to the years 1944 to 1948, the appellant's profit ratio for such years will be somewhat less. Next, it appears . . .

After a closer examination of the evidence, he stated:

I am accordingly, of the opinion that no firm conclusion can be drawn from the information presented either that additional expenses for paper and wages were in fact incurred or, if they were incurred, how much they amounted to, or in what years they were incurred and, while I do not discount entirely the evidence of Mr Lynch that he paid additional expenses in cash, his evidence falls short of satisfying me that any such additional expenses were incurred in all the years in ques tion and leaves me with no means of determining either the years in which such additional expenses were incurred or the amounts incurred.

Moreover, even if evidence by comparable entities which met the appropriate requirements was submitted to the Court, I do not think it would be bound by such evidence. It would simply be expert evidence, which can only lead to a recommendation. In my view, the recommendation can only be followed with some reservations, taking into consideration the reasons preventing the taxpayer from not [sic] presenting direct evidence with supporting documentation, as for example its being destroyed by fire. In a case such as that before this Court, with a fraudulent system of double accounting in which all documentation was destroyed by the taxpayer because it was too incriminating, how can such evidence be accepted without reservations? I do not think it can. If the Court were bound by conclusions from evidence of this type it would be ignoring the fact that under the Income Tax Act and the Regulations a taxpayer is required to retain supporting documentation. The taxpayer would thus be encouraged to have no accounting system and not to retain supporting documentation, as he could then present “expert” testimony based on comparisons.

In conclusion, Mr Shinder's evidence on this point cannot be admitted.

4.03.4 As the expert testimony has been rejected, the Court must again turn to the decision it will render as to the evidence presented on overtime, begun above in paragraph 4.02.2.2.

In view of the difficulty of quantifying these amounts, the Court might dismiss the appeal on this point, based again on the absence of supporting documentation and its destruction due to fictitious accounting systems. On the other hand, because of the testimony heard, the Court is persuaded that the amounts were paid in cash for overtime done. In view of the number of employees and the number of hours involved, the Court is persuaded that Leeds paid at least $15,000 in each of the years 1972, 1973,1974 and 1975. This amount is accordingly allowed as a deduction in calculating Leeds' income for the said years.

4.03.5 Harry Abelson, 1971-73, prescribed years

4.03.5.1 The reassessments made of the appellant Abelson on November 3, 1978 related to the years 1971-75. It was admitted by the respondent that the reassessments for 1971-73 were beyond the four-year deadline stated in subsection 152(4), which reads as follows:

Sec 152(4) The Minister may at any time assess tax, interest or penalties under this Part or notify in writing any person by whom a return of income for a taxation year has been filed that no tax is payable for the taxation year, and may

(a) at any time, if the taxpayer or person filing the return

(i) has made any misrepresentation that is attributable to neglect, carelessness or wilful default or has committed any fraud in filing the return or in supplying any information under this Act, or

(ii) has filed with the Minister a waiver in prescribed form within 4 years from the day of mailing of a notice of an original assessment or other notification that no tax is payable for a taxation year, and

(b) within 4 years from the day referred to in subparagraph (a)(ii), in any other case,

reassess or make additional assessments, or assess tax, interest or penalties under this Part, as the circumstances require.

The evidence was that, on the one hand, the respondent had evidence that Leeds had $613,887.87 on hand (para 3.07.1 in fine), and on the other, had no evidence that Leeds had spent it in making under-the-counter payments in cash, and so not only disallowed the deduction by Leeds but assumed that Abelson had appropriated it.

Mr Taza, who spent a year investigating Leeds and Mr Abelson before making the assessment, said he found no trace of any such amount in Mr Abelson’s assets.

The income not reported between 1972 and 1975 amounted to $190,489, not $613,886 (para 3.13).

The evidence was also that Leeds issued fictitious purchase invoices amounting to $1,213,586.55, which it claimed as a deduction in computing income. Moreover, Leeds failed to report $120,128 in actual sales. This was certainly a fraudulent misrepresentation. Further, Leeds is a different legal person from Mr Abelson and the reassessments for 1971-73 of Mr Abelson are the ones beyond the four-year deadline, not those of Leeds.

4.03.5.2 However, Mr Abelson is the majority shareholder and manager of Leeds. He organized the false system [at] Leeds and carried out the fraud. He also personally received the money, according to the evidence, or at least it was under his control through Mrs Weinstock. This receipt, possession and control of the money existed before any possible use, whether personal or for the purposes of Leeds, to earn income for the latter (by paying for wages or otherwise).

Once evidence was presented that all the cash was not used for the company's purposes, the rest remains in his hands as principal shareholder: can this not be called appropriation? In the Court's opinion this question must be answered in the affirmative. He had the burden of showing that the failure did not result from a negligent misrepresentation. Paragraph 152(5)(b) reads as follows:

Sec 152(5) Notwithstanding subsection (4), there shall not be included in computing the income of a taxpayer, for the purposes of any reassessment, additional assessment or assessment of tax, interest or penalties under this Part that is made after the expiration of 4 years from the day referred to in subparagraph (4)(a)(ii), any amount

(b) in respect of which the taxpayer establishes that the failure so to include it did not result from any misrepresentation that is attributable to negligence, carelessness or wilful default or from any fraud in filing a return of his income or supplying any information under this Act.

On reviewing the facts stated in para 2.09.2.1, the respondent's evidence as to the use of personal funds from unreported sales and the facts concerning the business of G Domingue Reg'd (see para 2.09.2.2), it is hard not to conclude that, first, there were appropriations from the cash fund, and that the respondent was correct in issuing reassessments for the years prior to the four-year period specified in subsections 152(4) and (5).

I can only repeat the words of Marceau, J in Saykaly (para 4.02.6, CTC 705; DTC 6443), the facts in which bore some resemblance to those in the case at bar.

The respondent. . . could not, in the circumstances, be more specific and in the absence of any valuable explanatory factor or proof to the contrary, the inference that the appellant derived direct benefit from the proceeds of the fictitious payments and for the whole amounts of these payments cannot be escaped. The Minister could rely on subsection 8(1) of the Act for his reassessments.

In Saykaly, the Court also approved the issuing of reassessments for the prescribed years 1958 and 1959, that is, after the four years then specified in 46(4), now 152(4).

It is to be first noted that the point may have a certain bearing only as regards the question of whether, despite the expiry of the four-year period prescribed in paragraph 46(4)(b) of the Act, the Minister could proceed in 1966 with reassessments for the years 1958 and 1959. I said that in my view the funds of Francine Company up to the amounts represented by the fictitious overpayments had been appropriated for the benefit of the appellant and had actually been paid to her. It follows that, in not declaring these amounts in computing her income for the years 1958 and 1959, the appellant made a “misrepresentation”. I think that her “misrepresentation” was innocent, she not being aware of it, but it has been held repeatedly that a “misrepresentation”, though innocent, justifies the Minister in proceeding with a reassessment at any time (MNR v M Taylor, [1961] CTC 211; 61 DTC 1139, MNR v Appleby, [1964] CTC 323; 64 DTC 5199; MNR v Foot, 66 DTC 5072), as long as, according to Mr Justice Pratte’s decision in MNR v Bisson, [1972] CTC 446; 72 DTC 6374, the error committed by the taxpayer could be attributable to negligence on his part. It is obvious that a normally wise and cautious taxpayer would not have acted the way the appellant did. She claims that her behaviour was understandable, that it is normal for a wife to obey and trust her husband, “which is a rule of public social order” adds her counselor.

It is worth noting that the foregoing precedents referred to by Marceau, J applied until the end of 1971, and the fundamental principles of that case were a basis for subsection 152(5), cited above.

In the case at bar, the appellant’s participation in the misrepresentation and the systematic destruction of documents is far from being the "candour” of the appellant in Saykaly: and yet in that case the judge allowed the assessments.

This personal participation by Mr Abelson must be taken into consideration by the Court, as it prevents the best evidence being produced and the consequences of this must be borne by him. The effect of this lack of evidence is again to leave him responsible for the appropriations made. The evidence that the National Revenue auditor did not find all the missing assets in the possession of Leeds or Mr Abelson (see para 3.15) does not prove that there were no appropriations. Mr Abelson, in particular, had many opportunities to spend the money on his numerous companies (see para 3.05(e)) and his other personal occupations (see para 3.09.2.1(1) to (6)). The evidence showed that he made appropriations in other companies (see para 3.09.2.3).

There is no doubt that the misrepresentation mentioned in subparagraphs 152(4)(a)(i) and (5)(b) exists in the case at bar. The reassessments for 1971, 1972 and 1973 must be regarded as having been validly made.

4.03.6 Did Mr Abelson make appropriations?

As explained above in reviewing the facts to determine whether there were misrepresentations (para 4.03.5.2), the Court has also come to the conclusion that there were appropriations. They are equal to the total amounts assessed, less $15,000 a year, for 1972-75 (see para 4.03.4 in fine).

4.03.7 The amount of $15,000 a year in para 4.03.4 alters the calculation of the cumulative deductions account and affects the small business deductions for 1976 and 1977.

5. Conclusion

The appeal is dismissed for 1967, 1968, 1969, 1970 and 1971. It is allowed in part for 1972, 1973, 1974, 1975, 1976 and 1977 and the matter is referred back to the respondent for reassessment in accordance with the foregoing reasons.

Appeal allowed in part.