Smith v. Her Majesty the Queen, [1996] 3 CTC 2697, [1996] DTC 1638

McArthur J.T.C.C.: — John Smith entered into an agreement in May 1989 to provide services to St. Joseph’s General Hospital. In December of that year, he assigned the contract to 442849 Ontario Limited. The hospital paid the company $32,100 in 1990 and $60,000 in 1991. The Minister of National Revenue added these amounts to the income of the Appellant and the company for the 1990 and 1991 taxation years.

The issue is whether the sums are to be included in John Smith’s income as being taxable income or appropriations pursuant to subsection 15(1) of the Income Tax Act. An appeal by the company was withdrawn at the commencement of this trial.

The following includes my finding of the relevant facts from the evidence of the Appellant, his accountant, and an auditor with Revenue Canada:

The Appellant operated a convenience store, laundromat and other commercial ventures in 1989. He performed consulting work for the hospital in the relevant years. An audit revealed that neither the company nor the Appellant declared the approximate sum of $92,000 in income paid to the company.

To devote his time to consulting work, the company hired a manager to replace the Appellant. The Appellant did the bookkeeping to keep an eye on the company’s performance. The company’s bookkeeping was in disarray from at least 1987 and continued to be so through the relevant taxation years.

Income tax returns for both taxpayers were filed late. The Appellant’s returns reflected total income of approximately $800 in 1990, and $30,000 in 1991. The company’s financial statements credited the Appellant’s shareholder loan account with a total of $92,100 in consulting fees during these years.

About 1990, the Appellant sold a real property he owned personally. His counsel stated that the sale proceeds were available for the Appellant to live on, particularly in the 1990 year when he declared a total income of $800 personally.

During the relevant years, the Appellant was shouldered with the responsibility, maintenance and custody of three infant children. He had gone through a difficult divorce in the late 1980s and suffered physically and emotionally.

He was the directing mind of the company and owned all the shares. He stated that the company did not deliberately omit declaring the $92,000 as taxable income. He added that the hospital contract was transferred to the company on consultation with his accountant because, amongst other things, the company needed the income to remain solvent. He supplied the company’s financial information to the accountant, albeit late, and he relied on the accountant for the accuracy of the financial statements and income tax returns.

The accountant stated that his office prepared statements and returns from records provided to them and did not question the credit of $60,000 in 1990 and $32,000 in 1991 to the shareholder’s loan account.

The accountant’s statements included the often-used disclaimer that read, in part, “We have not audited, reviewed or otherwise attempted to verify the accuracy or completeness of ... information.”

The accountant stated that the Appellant was advised of the gist of the contents in the two statements and two returns prior to their release to the Department of National Revenue.

The $92,100 consulting fees were added by Revenue Canada to the company’s taxable income and the same amount to the Appellant’s taxable income for the relevant years. No penalties were levied.

— Off Record Discussion

— Brief Recess

HIS HONOUR: Thank you. We continue now that I have recovered my quotations.

Legislation

Subsection 15(1) of the Income Tax Act reads in part as follows:

Where, in a taxation year, a benefit has been conferred on a shareholder...by a corporation...the amount...be included in computing the income of the shareholder for the year.

The position of the Appellant, simply put, was that Mr. Smith did not receive any money or property from the corporation and therefore no benefit and there can be no taxation under subsection 15(1). There must be an actual transfer of money or property to the taxpayer which did not occur in the present case. He did not appropriate money or property from the company.

The position of the Respondent included that the Appellant appropriated the consulting fees from the company and a benefit was conferred on a shareholder within the meaning of subsection 15(1).

Analysis

Both Counsel referred the Court, amongst many others, to the cases of Chopp v. R., (sub nom. Chopp v. Canada) [1995] 2 C.T.C. 2946, 95 D.T.C. 527 (T.C.C.) and Robinson v. Minister of National Revenue, [1993] 1 C.T.C. 2406, 93 D.T.C. 254 (T.C.C.).

Both cases have been appealed by the Crown and are a waiting to be heard by the Federal Court of Appeal. In Robinson, the taxpayer deposited over $64,000 in a company of which he was the sole shareholder. The company’s accountants erroneously recorded this amount as a credit to Mr. Robinson’s shareholder loan account. The Minister of Revenue added $64,000 to Mr. Robinson’s personal taxable income as a shareholder benefit under subsection 15(1) of the Act.

Judge Rowe of this Court held that Mr. Robinson did not intend to, nor did he in fact, appropriate the $64,000 for his own benefit. The money remained in the company. It was an accounting mistake of parties acting in good faith and therefore, no appropriation by or benefit to the taxpayer. Unlike the present case, the state of the bookkeeping records of the company was not questioned. At page 2410 (D.T.C. 257), Tab 9, Judge Rowe stated:

The Appellant was the sole shareholder of the corporation and must either be responsible for taking unto himself or setting aside for special purpose something of value for the corporation or, as the directing mind of the corporation, be responsible for the bestowing or granting of a benefit, and at the same time in his personal capacity agree to accept it and adapt it for his own use.

In Chopp, John Chopp was the directing mind of the corporation. While he was on vacation, the company advanced over $28,000 to complete the purchase of a home for him. The sums were erroneously recorded in the company books as a legal expense, rather than a reduction in the shareholder’s loan account.

Judge Mogan concluded that for a benefit to be conferred on a shareholder under subsection 15(1), it must be with the knowledge or consent of the shareholder, or in circumstances where it is reasonable to conclude that the shareholder ought to have known a benefit was conferred. He decided to favour the taxpayer in that Mr. Chopp did not know of the error and did not benefit from it. He agreed with the decision in Robinson wherein Mr. Robinson did not know of the error, nor did he use the benefit. Judge Mogan went on to state, at page 2954 (D.T.C. 532), Tab 8,

I would not go as far as Judge Rowe in stating that the words used in subsection 15(1) refer to some form of action with a strong component of intent. I think a benefit may be conferred within the meaning of subsection 15(1) without any intent or actual knowledge on the part of the shareholder or the corporation if the circumstances are such that the shareholder or corporation ought to have known that a benefit was conferred and did nothing to reverse the benefit if it was not intended.

I agree with this reasoning and apply it to the present case. I find that there was not a genuine bookkeeping error. The company records were not kept to an acceptable level. Surely the taxpayer has to be held responsible for his own actions. He did the bookkeeping during the relevant years. He devoted most of his time as a consultant in order to fund a struggling corporation and provide for himself and three children. He knew or ought to have known that benefit was being conferred on him.

The payment to the company was not a single occurrence. Payments were made to the company almost monthly over a two-year period. He was warned by his accountant of the difficulties that could arise in assigning the hospital contract to the company. It is not the kind of amounts that would be overlooked. The company was having financial difficulties. In relative terms, $92,100 was an enormous sum to slip by without the Appellant realizing that he and the company had to pay income tax on it.

Having decided a benefit was conferred on the Appellant, how much was that benefit? The Appellant’s counsel argued no receipt, no taxation. He submits that the $92,100 was paid into the company and remained there. Mr. Smith did not receive the proceeds and therefore, did not benefit from them. He continued that to add $92,000 to Mr. Smith’s income would result in double taxation, a harsh result indeed.

The Appellant paid income tax on a declared income of approximately $30,000 in 1991. He was able to withdraw this $30,000 from the company largely as a result of the consulting fees being paid into the company. While he did not receive the balance of $62,100 as income, he and his company knew or ought to have known that a benefit was being conferred on him and he did nothing to reverse it until he was made aware of Revenue Canada’s audit in June of 1993.

The benefit to the Appellant was real. His shareholder loan account was credited with $92,100. This is a receipt. A taxpayer is certainly entitled to arrange his business affairs in accordance with the Income Tax Act in order to minimize the payment of income taxes. When dealing with a personal corporation at non-arm’s length, the taxpayer has to be vigilant and cross his t’s and dot his i’s.

In the present case, a troubled company received $92,100 and did nothing to report it as income. Its bookkeeping was lacking. The accountant did not correct the improper records. The income tax filings were late. The company showed an income of less than $10,000 in both years. Mr. Smith declared $800 in income in 1990 and approximately $30,000 in 1991.

I have no difficulty concluding that he knew that the amount was not reflected in the company’s income or his own income. $60,000 was paid into the company in 1990 and $32,100 in 1991. Mr. Smith declared income of approximately $30,000 in 1991, but while he did not receive the 60,000 in 1990, Mr. Smith did benefit. The company remained solvent and the net worth of his shareholdings must have increased.

I find there was a taxable benefit conferred on the Appellant in 1990 in the amount of $60,000 and in 1991 of $2,100 being the difference between the $30,000 upon which he had paid tax and withdrew from the company and $32,100. Those amounts are to be included in computing the Appellant’s income for the respective years.

The appeal is allowed without costs and the assessments are referred back to the Minister for reconsideration and reassessment to include $60,000 in 1990 and $2,100 in 1991 to the Appellant’s taxable income.

Thank you.

Appeal allowed.