Merchant v. R., [1998] 3 CTC 2505, 98 DTC 1734

Bowman T.C.J.:

These appeals are from assessments for the appellant’s 1990, 1991 and 1992 taxation years. The issues as they appear from the notices of appeal and the replies are as follows:

(a) whether the 1990 reassessment dated December 2, 1994 is statute- barred;

(b) whether the appellant is entitled to deduct professional expenses of $10,838 and carrying charges of $31,133;

(c) whether the Minister of National Revenue was correct in adding $33,525 professional income from partnerships;

(d) whether the Minister was correct in imposing penalties.

The notice of appeal for 1990 also refers to the Minister’s failure to respond to a T-l adjustment.

The trial lasted 7 days — August 11, 12, 13 and 14, 1997 and February 23, 24 and 25, 1998. Yet it boiled down essentially to a number of factual issues that could and should have been resolved at the assessments level or the appeals level.

I find as a fact that Mr. Merchant was uncooperative in the course of the audit by the assessor Mr. Steven Kendall Button to the extent that Mr. Button was unable to perform the audit in a manner that would in all probability have resolved many of the issues. Mr. Merchant had a second chance when the matter was at the appeals level after the filing of notices of objection. He refused to make any representations to the appeals officer, evidently on the theory that he would take the matter to court. The production of documents and the examination for discovery of Mr. Merchant were a shambles largely as a result of Mr. Merchant’s stonewalling tactics. This necessitated the bringing of motions by the Crown that should not have been necessary.

The system of assessment, objection and appeals from income tax assessments in Canada is one that works very well. Indeed, in my experience it is one of the best in the world. At every stage taxpayers or their representatives are entitled to meet with representatives of the Government in an attempt to resolve outstanding issues. The result is that many disputes are settled. The success of the system requires however good faith and openness on both sides. It does not work if the appeal process is treated, as it was here, as an exercise in gamesmanship and obfuscation.

In this case, documents were produced right up to the last minute. The proceedings lasted seven days. Any issues of substance (as opposed to the laborious proof of receipts that should have been produced at the audit or objection level) could have been disposed of in a day. A substantial part of the trial was devoted to proving small expenditures - a matter that should have been resolved at the assessments level when Mr. Button was auditing the file.

Where a large number of documents, such as invoices, have to be proved it is a waste of the court’s time to put them in evidence seriatim. The approach set out in Wigmore on Evidence (3rd Ed.) Vol IV, at s. 1230 commends itself:

s. 1230(11): ...Where a fact could be ascertained only by the inspection of a large number of documents made up of very numerous detailed statements — as, the net balance resulting from a year’s vouchers of a treasurer or a year’s accounts in a bank-ledger - it is obvious that it would often be practically out of the question to apply the present principle by requiring the production of the entire mass of documents and entries to be perused by the jury or read aloud to them. The convenience of trials demands that other evidence be allowed to be offered, in the shape of the testimony of a competent witness who has perused the entire mass and will state summarily the net result. Such a practice is well- established to be proper.

This passage was cited with approval by Wakeling J.A. in Sunnyside Nursing Home v. Builders Contract Management Ltd. (1989), 75 Sask. R. 1 (Sask. C.A.) at p. 24and by MacPherson J. in R. v. Fichter (1981), 37 Sask. R. 128 (Sask. Q.B.) at p. 129. I am in respectful agreement.

The practical result of this, apart from the fact that a case that should either have been settled or should, at most, have taken one day, lasted seven days, is that the case comes before the court without any of the preliminary factual determinations being made by the Minister that normally form the basis of the identification of the issues that must be decided by the court. An example of this is the expenses that were claimed by Mr. Merchant and disallowed. Mr. Button stated that as part of the normal audit procedure he would examine vouchers, receipts and other records to determine if the taxpayer had in fact incurred the expenses. He would then routinely examine the records of other entities with which the taxpayer was associated to ensure that none of them was also claimed by one of the several partnerships of which the appellant was a member or by his corporation, or whether he was reimbursed by them. The assessor was prevented from determining this.

Mr. Merchant has come before this court expecting the court to perform functions that should have been performed at an audit by an assessor. In doing so he assumes an onus of establishing all constituent elements entitling him to relief. It is not the court that imposes on him a higher onus than that imposed on other litigants. It is he who, by his own actions at all levels right up to his appearance in court, has imposed on himself a heavy burden resulting from his preventing the officials of the Department of National Revenue or counsel for the respondent from determining any facts that would facilitate the identification of the points, if any, that ought to be in issue. The assessor, Mr. Button, was in the court room throughout the proceedings and he testified. Contrary to the highly unfair criticisms levelled at him I found him an honest and trustworthy witness who went about his job in a workmanlike and fair way but he was faced with impossible obstacles. To the extent that there is any conflict between Mr. Button’s and Mr. Merchant’s testimony in respect of the conduct of the audit I accept Mr. Button’s testimony. As new documents kept being produced — right up to almost the last day — he was forced to examine them in rather difficult circumstances in an attempt to fill in some of the gaps left in the audit that had been frustrated by Mr. Merchant. In this I imply no criticism of Mr. Tochor, who presented the case skilfully and professionally. However, he had an impossible client.

1990

Statute-barred issue

The first point is whether the 1990 assessment is statute-barred, by reason of having been made outside the normal reassessment period, which is three years from the date of the original assessment.

The appellant attached some importance to the fact that the original assessment for 1990 was not issued until December 4, 1991. It was also contended that the notice of the original assessment was never received.

The reassessment for 1990 that is under appeal is dated December 2, 1994. If, as contended by the appellant, the original assessment was never issued, the three year period did not start running and so the reassessment of December 2, 1994 is the original assessment and is not statute-barred. If the original assessment was in fact issued on December 4, 1991 the assessment of December 2, 1994 is within the three year period. Neither hypothesis supports the appellant’s position that the year was statute-barred.

Although the point was not pleaded, the appellant argued also that the assessment was not made with due dispatch. I am not prepared to find that the original assessment was not made on December 4, 1991. In any event the due dispatch requirement applies to the initial assessment under paragraph 152(1), not to a subsequent reassessment. A reassessment made within three years of the date of the original assessment is not unduly delayed. Indeed, given Mr. Merchant’s deliberate attempts to frustrate the audit, it is surprising that it did not take longer.

A number of issues arise in 1990 having to do with the computation of Mr. Merchant’s income. As a preliminary matter it should be observed that Mr. Merchant is, and, during the years in question, was a very successful legal practitioner in Saskatchewan and elsewhere. He was a rainmaker — a person who brought to the firm a large number of clients, and contributed significantly to the prosperity of the law firms in which he was a partner. Some of the difficulty in determining Mr. Merchant’s income in the years in question is the fact that each time a new partner joined him in the practice of law a new partnership was formed. Hence, Partnerships Pl, P2, P3, P4 and PS, the last one being the Merchant Law Group. He also had a corporation known as Merchant 2000 Ltd. Whatever confusion may have been engendered by this proliferation of business organizations was exacerbated by Mr. Merchant’s stonewalling tactics vis-a-vis the Department of National Revenue. The only way in which I can impose some sort of order on the somewhat chaotic state of affairs is to take the replies to the notices of appeal item by item and deal with the issues that appear from them. The notices of appeal are unhelpful.

Paragraphs 5(d) and (e) of the reply for 1990 state that Mr. Merchant declared income from Partnership P4 of $12,176 whereas it should be $13,176. The appellant concedes this point.

Paragraph 5(f) states that P3 transferred certain expenses in the amount of $22,530.78 to P4, without any corresponding reduction in P3’s expenses. Mr. Button’s assumption was that both partnerships were claiming the same amount. That assumption has not been rebutted. He reduced P3’s expenses by $22,530.78. There has been no evidence to cast any doubt on the correctness of what he did. The statement by the appellant’s accounting witness, Mr. Eli Fluter CA, that the books of the two partnerships balanced in my view proves nothing. It does not prove that both partnerships were not deducting the same amount.

Paragraph 5(g) refers to the fact that P3 paid expense allowances of $6,000 allocated to the partners in predetermined monthly amounts, without any accountability for their use. Paragraph 5(k) states that the same was true of P4, in the amount of $11,725. Mr. Button disallowed these amounts in computing the income of the two partnerships and this increased Mr. Merchant’s proportionate share.

This raises an arguable point. The non-accountable expense allowances for which apparently no vouchers or receipts were required by the partnerships is not an acceptable way of proceeding where substantial amounts are involved. Expenses incurred on firm business, if charged to the firm by partners or employees, should ideally be backed up by specific substantiation. Is it so difficult, even in a busy law firm where undoubtedly travel and entertainment expenses are incurred, to provide vouchers to the office manager? Although the allowance may have been reasonable in light of the fact that, after Mr. Merchant started claiming specific expenses of the type that this allowance was designed to cover, his claims exceeded the amount paid to him as an allowance, I see no reason why such indemnification cannot be substantiated. I therefore disallow the claim.

Paragraph 5(h) refers to a deemed disposition of goodwill on the dissolution of P3, in the amount of $1,507. The respondent concedes this point.

Paragraph 5(i) simply summarizes the effect of the adjustments in paragraphs 5(f), (g) and (h) so that the increase to Mr. Merchant’s income from P3 is $17,722.29. This figure will have to be adjusted to take into account the concession in respect of paragraph 5(h).

Partnership P4

Paragraph 5(j) alleges the deduction of $15,436.48 in expenses by the partnership without any supporting documentation.

It is my view that there is no requirement in law that expenses be supported by receipts or other corroboration if such expenses can be supported by credible viva voce testimony and the amounts can be identified with a reasonable degree of specificity (Weinberger v. Minister of National Revenue (1964), 64 D.T.C. 5060 (Can. Ex. Ct.)). Subsection 230(2.1) of the Income Tax Act specifically requires persons carrying on business as lawyers to keep books and records. Why lawyers are singled out is uncertain, but I do not regard compliance with section 230 to be a prerequisite to the deductibility of expenses if they can otherwise be proved. Failure to keep books and records carries its own sanction but had Parliament intended that sanction to include non-deductibility of expenses it would have been quite capable of saying so.

I am satisfied from an examination of Tab C of Exhibit A that $6,587.50 has been established. A number of other items listed in that exhibit totalling $15,436 lack the degree of specificity as to the purpose of the expenditures to justify my interfering with the assessor’s decision.

Paragraph 5(m)

The respondent concedes that a further deduction of $10,838.39 is justified. Penalties were imposed in respect of this item. Since the Department is allowing the deduction the penalties on this item should be deleted.

Paragraph 5(p)

The appellant deducted interest and carrying charges of $33,113.71. He now claims $32,629.85. These expenses are listed under Tab K (Exhibit A- 14) and I am satisfied that they were paid. They should be allowed as deductions and the penalties in respect of this item should be deleted.

1991

Paragraph 5(c) lists amounts of $24,574.38 claimed as expenses. The largest item in this amount is $17,931.51. Of that $5,186.80 was for contributions to charities and participation in events.

So far as the charitable donations are concerned, the appellant is claiming anything for which he did not have a charitable receipt as a promotional expense. I am not prepared to extend the decision of the Exchequer Court of Canada in Olympia Floor & Wall Tile (Que.) Ltd. v. Minister of National Revenue (1970), 70 D.T.C. 6085 (Can. Ex. Ct.) to the point contended for by the appellant. Mr. Merchant may be an indefatigable self-promoter but it would require far more cogent evidence than I have seen to bring him within the principle stated in Olympia. The same is true of his political contributions. The deduction of charitable contributions and political contributions is covered by a very specific regime under the Income Tax Act. I do not propose to drive a coach and four through those provisions.

The appellant claims $7,860 for entertainment expenses of a promotional nature. Of this, $6,379.46 was for a gala party “Your Friendly Neighbourhood Solicitor”. This latter amount has been proved and I regard it as a legitimate promotional expense.

The appellant claims $4,768.55 for government promotion expenses. He is very prominent as a Liberal politician. Many of these expenses are undoubtedly intended to promote his fortunes within the Liberal party. I cannot however for that reason alone hold that they are not intended to promote his business. His politics and his law practice are inseparable and seem to have a symbiotic relationship. Nonetheless, I am not prepared to allow the expenditures because the printouts under Tab Q are insufficient to establish either the incurring of the expenses or their purpose.

Business taxes, fees, and licenses are claimed in the amount of $4,438.76. The appellant now claims $10,158.80. I am prepared to accept the Balfour Moss legal costs of $6,105.23. This was in connection with a legal action brought by Mr. Merchant against the Canadian Broadcasting Corporation. The other expenses may have been incurred but it has not been established that one or other of his law firms did not pay them. They appear to be the sort of expenses that the law firm would pay. If Mr. Merchant expects this court to act as an income tax auditor he should not be surprised if the court draws an adverse inference from his failure to establish every constituent element necessary to the deductibility of a claimed expense. It was precisely this sort of thing that Mr. Button, having found other instances where expenses were claimed twice, was unable to verify.

The respondent concedes $1,100 as a home office expense.

Carrying charges and interest charges — The appellant claims $39,044. These have been proved and I accept that they are deductible, except for the Rosecrest mortgage interest of $7,413.69. The appellant never owned Rosecrest and there is no legal basis upon which he can deduct the mortgage interest under paragraph 20(1)(c). The penalties on this item should be deleted.

Bad debt expense — $111,672. The Partnerships P4 and P5 had already deducted a reserve for bad debts or doubtful debts. The appellant then claimed the balance of the debts as a bad or doubtful debt. I must confess I have seldom seen anything quite so far-fetched. The proposition is that one partner in a firm can, after the firm has deducted a bad or doubtful debt allowance, take the remainder of the firm’s debts and personally claim a bad or doubtful debt allowance in respect thereof. The proposition needs only to be stated to be defeated by its own patent absurdity. The claim was properly disallowed and the penalties were properly imposed. The conduct is well within the type contemplated by subsection 163(2).

Business losses — $728.26. These have been proved and are allowed.

Rental losses — $3,995.20. The appellant now claims $20,646. The additional amount was not claimed in the notice of appeal. Although financial statements were produced at trial there was no acceptable evidence adduced in support of their accuracy or to support the losses claimed by the appellant.

Expense allowance — $10,502. This claim has not been pleaded and no error in the Minister’s treatment of this amount has been established. It is disallowed.

1992

Accounting, legal and consulting expenses in the amount of $3,517.50 were claimed. Of this, $2,318.87 was proved and should be allowed.

Advertising and promotion —- The appellant has claimed $15,682.35. This amount has been proved and is deductible.

It has not been established that the cost of $9,252.71 relating to the Austrian Consulate is an appropriate business expense. In the absence of adequate evidence to the contrary I think the cost of the appellant’s being the honorary consul of Austria should be treated as personal.

Business tax, fees, licence, dues — $3,842.72. The payment of this amount has been proved. It has not however been established that one or other of Mr. Merchant’s law partnerships did not pay this amount or that they did not already deduct the cost. Given the manner in which these expenses have essentially been dumped on the court’s doorstep at the eleventh hour, it would be dangerous to find, on a balance of probabilities, that they had been paid by Mr. Merchant and were deductible by him. The point was not pleaded in the notice of appeal and, according to the reply $3,842.72 was claimed. Mr. Merchant now claims $5,059.43, including, as an example of the fatuity of the behaviour of Mr. Merchant, $8.37 for dry cleaning of his vest and gown. To clutter up the record with this sort of thing is an insult to the court.

Insurance — $1,550.45. This has not been proved.

Office expenses — $2,077.52. It has not been established that these expenses relate to the earning of income.

Salary — $180. This was allegedly paid to Mr. Merchant’s wife allegedly for doing some filing in connection with some board that Mr. Merchant was on. This claim is ridiculous.

Collection costs — $5,674. Collection costs are generally a permissible deduction. Mr. Merchant should however have charged the firm for it and the firm should have claimed it, with the result that Mr. Merchant would have been entitled to his proportionate share.

Business use of home — $1,496. The Crown concedes this item.

Carrying charges and interest charges — The appellant claims $40,878.04. He proved $35,136.45. This is deductible, except for the Rosecrest mortgage renewal fee of $85.

Rental losses — $13,180 was allowed. The appellant claims an additional $6,713. It has simply not been proved that there were additional losses.

Expense allowance — $10,808.84. There is insufficient evidence on this point to warrant any adjustment.

Partnership P4 income — $75,592. The appellant simply failed to declare $75,592 as income from partnership P4. This amount is plainly taxable and its omission from his return was at least grossly negligent, if not deliberate. The penalty is affirmed.

Exploration and development expenses — $2,500. This has been proved.

Non-capital losses from other years — $46,117. This has not been proved but I assume if it is available the Minister of National Revenue will take it into account in reassessing.

Assignment of tuition from child — $4,000. This was not pleaded and has simply not been proved.

The appeals are allowed and the assessments are referred back to the Minister of National Revenue for reconsideration and reassessment in accordance with these reasons.

In considering the substantive merits of the issues raised I have ignored Mr. Merchant’s unacceptable behaviour and focused solely on the legal and factual issues. In the determination of the merits of a case a litigant’s behaviour is generally irrelevant. The place to deal with unacceptable conduct is in the award of costs.

Mr. Merchant has been given all that he could reasonably expect in respect of the substantive issues. Moreover, he has been given great leeway in respect of the production of documents and the raising of issues. He has, however, treated this court, its rules, the orders of the court and counsel for the respondent, who is an officer of the court, with disdain.

It is not inconceivable that had he behaved less outrageously at the audit, objection and appeals level he might have obtained further relief that I am not, on the evidence, prepared to give him. However the court is not the place to perform an income tax audit and to foist that function upon a judge is a dangerous and risky game and, as will be apparent from my award of costs, an expensive one.

It is unusual to award costs against a party who has been partially successful, and particularly solicitor and client costs. The matter is discussed in Young v. Young, [1993] 4 S.C.R. 3 (S.C.C.). The general rule is that a successful litigant is entitled to party and party costs. Where success is divided it is not unusual for no order to be made for costs. To depart from the usual rule requires unusual circumstances. For a successful or partially successful litigant

(a) to be deprived of costs,

(b) to be ordered to pay party and party costs,

(c) to be ordered to pay costs to the other party on a solicitor and client costs,

requires a measure of reprehensibility. To award solicitor and client costs against a litigant who has achieved the degree of success that Mr. Merchant has requires a high degree of reprehensible conduct. There must, to use the words of McLachlin J. in Young (supra) at p. 134, be “reprehensible, scandalous or outrageous conduct on the part of one of the parties”.

The jurisprudence on this point has been thoroughly reviewed by Sarchuk J. in Bruhm v. R. (1994), 94 D.T.C. 1400 (T.C.C.), and I shall not repeat what he has said. I agree that to award solicitor and client costs against a partially successful party is rare and should be done only in exceptional circumstances. The presiding judge has, under section 147 of the General Procedure Rules, wide discretionary power in respect of the awarding of costs. This is a case for ordering Mr. Merchant to pay the Crown’s costs on a solicitor and client basis. From the outset he has done everything possible to obstruct the Crown in its attempt to put its case forward in an orderly way. He has produced documents up to the last minute. He has rendered impossible the conduct of the discovery. The abuse of the assessor, who acted properly throughout, is intolerable. Generally speaking, conduct prior to the commencement of the action is not relevant to the award of costs. The rule is not invariable. Here Mr. Merchant has deliberately frustrated the audit process and the objection process with a view to having matters dealt with by the court that should never have had to come before it. His conduct prior to commencement of the appeal and prior to trial has had a direct impact upon the manner in which the trial proceeded. He has caused a trial that should have lasted no more than one day to last seven days. Moreover such success as he has achieved at trial is no more than he could have achieved at the audit, objection or discovery level had he not seen fit to obstruct the orderly process of assessment and objection laid down in the Income Tax Act and the procedures set out in the rules of this court.

I find Mr. Merchant’s conduct warrants the awarding of costs against him on a solicitor and client basis.

The respondent is entitled to her costs, including the costs of the trial and of all motions prior to trial, on a solicitor and client basis.

Appeal allowed.