Hagon v. R., [1999] 2 CTC 2436

Bowie T.C.J.:

The Appellant has been reassessed for income tax for the taxation years 1989, 1991 and 1992. The Minister of National Revenue (the Minister) contends that the Appellant did not disclose all of his income when filing his returns for those years. In addition to the amounts added to income, the reassessments include penalties levied under subsection 163(2) of the Income Tax Act for each of the years in question. These penalties were assessed on the basis that the Appellant failed to disclose certain amounts of income in each of the years, and that he did so fraudulently, knowingly, or at least in circumstances which amount to gross negligence on his part. The Respondent has also pleaded in the Reply that if the penalties are not warranted under subsection 163(2) then the penalties for 1991 and 1992 are justified under subsection 163(1), because the Appellant was convicted of failing to report a part of his income for the year 1989.

The Appellant, during the years in question, was engaged in a business with his brother Jeff under the name G & H Cabinets. During 1989 they and one other individual were equal partners. At the end of 1989, the Appellant and his brother bought out the other partner. The business was incorporated at the beginning of 1990 under the name G & H Cabinets Ltd., and they continued to operate it on the basis of equal ownership.

The Appellant’s position with respect to the assessments is that he was the person concerned with the operational aspects of the business, and that his brother was responsible for the financial side. The business consisted of making, selling and installing kitchen cabinets. The Appellant was in charge of the shop where these were produced, and he went out to the locations where they were being installed to do that work. Other than making the bank deposits from time to time, he says that he was not involved in the finances at all, and that he knew nothing of the way in which the books were kept, at least until after the business became bankrupt in or about 1994.

The original assessment of the Appellant for 1989 was dated April 6, 1990. It was based on the Appellant’s declared income, consisting of $785.76 in family allowance payments, $12,555 in unemployment insurance benefits, and investment income of $188.14, to which the Minister added $1,000 in employment income which the Appellant received from Rato Enterprises Inc. (Rato) for work that he did for that firm. The Appellant did not dispute at the hearing that he had in fact received this amount from Rato; he explained its non-inclusion on the basis that he did not have a T4 form from Rato, and that he therefore inadvertently failed to disclose it to his tax preparer. The reassessment for 1989 from which the appeal is brought is dated October 27, 1994. The Respondent therefore has the onus of proving that the Appellant had, for that year, made a misrepresentation which can be attributed to neglect, carelessness, wilful default, or fraud. [1] The Minister also has the onus of proving that the Appellant either knowingly, or through gross negligence, understated his income for all three years, in order to establish that the Appellant is liable to the penalties assessed. To meet the onus in respect of these matters, counsel for the Respondent called the Appellant as a witness. She also called Mr. Matthew Talbot, who worked for the company in 1989. He later opened his own renovation business, and became a customer of G & H Cabinets Ltd. Mr. Robert Schell, an investigator employed by Revenue Canada, also gave evidence for the Respondent.

I did not find the Appellant to be a reliable witness. He admitted during the hearing that he had collected unemployment insurance benefits in 1989 while working 16 hours a day; he did not report the fact that he had worked to the unemployment authorities. He was confronted during his evidence with an application for a loan which he had completed and submitted to the Westminster Credit Union, in which he claimed to have a net income of $3,800 per month, at a time when he declared a gross income of about $10,000 annually. He testified that he had deliberately overstated his income to the credit union to improve his prospects of getting the loan. As will appear, I think it more likely that he was telling the truth to the credit union, and not to the Minister of National Revenue. He offered an unconvincing explanation of how he could support his family on the income he declared during the years in issue, based upon rental income which he said he received. At first he referred to rental income paid to him by his mother; later in his evidence it became rental income received from both his mother and the tenant of a basement apartment. The Appellant has a grade nine education, and I believe him when he says that he did not have much understanding of accounting. However, I also believe that he was quite willing to give whatever evidence he felt would be to his advantage. Where his evidence is self-serving and uncorroborated, I do not accept it.

There are other difficulties in reconstructing the financial affairs of the business. The Appellant’s brother Jeff is now living in England, and so was not available to give evidence. The financial records of the business, both as a partnership in 1989 and later after it was incorporated, were kept, it appears, in a most haphazard way. There do not appear to have been any proper books of account. Once a month the bank deposit slips, cheque stubs and other original vouchers were turned over to a bookkeeping firm, which seems to have maintained some records. These disappeared, I was told, before the trustee in bankruptcy could obtain them. Their disappearance was not explained in the evidence before me. Mr. Schell did have access to some records during the investigation that he conducted, and I admitted the extracts that he took from them into evidence. They provide at least a partial picture as to how the company conducted its affairs. Unaudited statements for the partnership were prepared for the year 1989, and these too were entered in evidence.

I pause here to deal with the Crown’s plea of issue estoppel. In February 1995, Robert Schell swore an information in the Provincial Court of British Columbia which charged the Appellant and his brother with various violations of the Income Tax Act. There were ten counts in all. Two were against the brothers jointly, and there were four separate counts against each.

No certificate of conviction was entered in evidence, but Mr. Schell and the Appellant both testified that the Appellant was convicted on count eight. That count charged him with making a false statement in his 1989 income tax return, and specifically, with stating that his taxable income was $13,528.90, and thereby failing to report additional income in the amount of $10,759.50. The conviction on this count came about in the following way. After two days of trial, the Court dismissed two of the counts against the Appellant. At that point there were discussions between the Crown and the Appellant’s lawyer, and a bargained plea of guilty was entered to count eight, not for the full amount charged, but for the lesser amount of $7,134.51. This is the Appellant’s share of the partnership profit as indicated by the unaudited statements for 1989. The Appellant was then convicted in accordance with the guilty plea, and the other counts against him were abandoned by the Crown. It is this conviction that the Crown contends raises an issue estoppel against the Appellant.

It is well settled that a conviction under the Income Tax Act may, in proper circumstances, give rise to an estoppel in later civil proceedings under the Act, Van Rooy v. Minister of National Revenue [2] In the present case there is no problem of identity of issue, as there was in Van Rooy; the conviction was as to the amount of $7,134.51, which is not all, but is an identifiable part, of the income added by the reassessment under appeal for 1989.

Nevertheless, it is my view that this is not a proper case in which to permit an estoppel to be raised. The evidence shows that the conviction arises out of a plea bargain, a process in which there is necessarily some give and take on both sides. This is the sort of circumstance that Blair J.A. had in mind in the Del Core [3] case, where he said of a conviction in criminal proceedings that: [4]

Such evidence constitutes prima facie and not conclusive proof of the fact of guilt in civil proceedings. The prior conviction must of course be relevant to the subsequent proceedings. Its weight and significance will depend on the circumstances of each case. ...

He then went on to point out that the effect of a conviction may be mitigated by explanation of the circumstances surrounding the conviction.

In the present case, the fact that the conviction arose out of a guilty plea which was part of a plea bargain is significant. There may have been very sound practical reasons other than guilt that motivated the plea. Counsel has not referred me to any authority dealing with the effect to be given to a bargained plea of guilty, and absent such authority, I am not inclined to find that the Appellant is estopped in this case.

I turn now to the evidence relating to the alleged failure to report income. From the evidence available, it appears that the revenue of the business was not all recorded in the books during 1989, 1991 and 1992. The evidence establishes that on a number of occasions, payments for goods and services supplied by the business were made in cash to Jeff Hagon. This cash was subsequently deposited to the business bank account, but it was described not as sales, but as loans advanced by the two brothers to the business. This description was placed on the deposit slips by Jeff Hagon, and as a result, the bookkeeper recorded what were in reality sales as advances made to the business by the Appellant and his brother. Drawings made by them were then recorded as being debits to their loan accounts, [5] rather than to salaries.

The Appellant was adamant in his evidence that this was being done by his brother without his knowledge, and that he cannot be held responsible for it. He also gave evidence that on a number of occasions, how many is not certain, he took out mortgages against the homes that he lived in during this period to provide funds to keep the business afloat. These, he said, he turned over to his brother. Beyond that, he had no specific knowledge of the amounts, the dates, or the disposition of the proceeds of these loans.

I am satisfied on the evidence that the Appellant did in fact fail to declare his true income when he filed his 1989 tax return. The financial statements of the partnership show a partnership income of $21,403.51, attributable equally to the Appellant, his brother, and the third partner. The Appellant’s share is $7,134.51.

In addition, the evidence of Mr. Talbot establishes that there was a further $7,250 which was paid in cash to Jeff Hagon by one Max Anderson, who carried on business as Newport Concrete, for goods sold or work done by the partnership during the year 1989 which should have been, but was not, recorded as sales during that year. Instead, it was recorded as being advanced to the business by the brothers. This resulted in the understatement of the income of the partnership in that amount. The Appellant’s share of the undeclared income arising from this item is $3,625, for a total of $10,759.50 undeclared income from the business in 1989, over and above the $1,000 in earnings from Rato, which was included in the original assessment, although not declared.

The Appellant did not declare any income from the business in 1989. I do not accept his explanation that he did not know that he had any to declare. He admitted during his evidence that he received cash from the business from time to time. He minimized the amount. He said that it was “small amounts a couple of times”. He said small amounts meant $700 to $1,000. I find that the amounts he received in cash were more frequent than that. He testified that he was working 16 hours per week on the production side of the business at that time. I do not believe that he would be content to take only $1,400 or $2,000 out of the business in cash to support himself, his wife and two children for all of 1989. I find that the Minister has discharged the onus of showing that the Appellant was at least neglectful in understating his income for 1989 by the full amount of $10,759.50 added by the reassessment. I shall return to the issue of the penalty assessed for 1989.

I turn now to the years 1991 and 1992. The Appellant was reassessed for 1991 to include in his income $6,350 over and above that which he had declared. The evidence establishes to my complete satisfaction that Matthew Talbot, who by 1991 had left the employ of the company and became a customer of it, paid a total of $12,700 in cash to Jeff Hagon for goods supplied to him by the company, and that this cash was not recorded as sales in the company’s accounts. Instead, it was later deposited to the company’s account at the bank, with the notation on the deposit slip that it represented an amount loaned to the company by the Appellant and his brother. The inevitable result was that the bookkeeper recorded the amounts as shareholder loans. By this subterfuge, the company was made to confer a benefit on each of the Appellant and his brother, in the amount of $6,350: see Kennedy v. Minister of National Revenue^ [6] This benefit was not declared by the Appellant in filing his return for 1991.

The reassessment for 1992 added $16,517.50 to the Appellant’s income. This is one half of the total amount of $33,035, which is the sum of five amounts paid by customers of the company in cash and, by the same subterfuge that I have described above, recorded in the company’s accounts as loans from the Appellant and his brother, rather than as sales. Not only did the Appellant fail to displace the assumptions made by the Minister in respect of these amounts, but the evidence of Mr. Schell, based upon his review of such few records as he was able to gain access to, confirms those assumptions. I find that a benefit was conferred on the Appellant in 1992, as assessed, and that it was not declared by him.

I turn now to the question of the penalties assessed for the three years under appeal.

In reassessing the Appellant, the Minister has levied penalties of $924.38 for 1989, $135.99 for 1991 and $1,056.06 for 1992, all under subsection 163(2) of the Act. That subsection reads as follows:

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 the greater of $100 and 50% of the aggregate of

(a) 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 and if his tax payable for the year were computed by subtracting from the deductions from the tax otherwise payable by him for the year such portion of any such deduction as may reasonably be attributable to the false statement or omission

exceeds

(11) 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,

(b) the amount, if any, by which

(1) the amount that would be deemed by subsection 122.2(1) to be paid for the year by him or, where he is a supporting person of an eligible child of an individual for the year (within the meaning assigned by subsection 122.2(2)) and resided with the individual at the end of the year, by that individual, as the case may be, if that amount were calculated by reference to the information provided in the return filed for the year pursuant to that subsection

exceeds

(ii) the amount that is deemed by subsection 122.2(1) to be paid for the year by him or the individual referred to in subparagraph (i), as the case may be,

(c.1) (Repealed by 1990, c.45, S. 51(1).)

(c) the amount, if any, by which

(1) the aggregate of all amounts each of which is an amount that would be deemed by subsection 122.5 to be paid by that person during a month specified for the year or, where that person is a qualified relation of an individual for the year (within the meaning assigned by subsection 122.5(1)), by that individual, as the case may be, if that aggregate were calculated by reference to the information provided in the prescribed form filed for the year under subsection 122.5

exceeds

(11) the aggregate of all amounts each of which is an amount that is deemed under section 122.5 to be paid by that person or that qualified relation during a month specified for the year, and

(d) the amount, if any, by which

(1) the amount that would be deemed by subsection 127.1(1) to be paid for the year by him if that amount were calculated by reference to the information provided in the return or form filed for the year pursuant to that subsection

exceeds

(ii) the amount that is deemed by subsection 127.1(1) to be paid for the year by him.

The essential ingredients, so far as they apply here, are a false statement in the income tax return for the year, and that the false statement be made knowingly, or as a result of gross negligence on the part of the taxpayer. I have already found that the Appellant made the false statements alleged. The remaining issue is whether he did so knowingly, or as a result of gross negligence.

So far as 1989 is concerned, I find that the Appellant made the false statement knowingly, insofar as the income from Rato is concerned. He knew very well that he had worked for and been paid by that company dur- ing the year. I believe that he thought that because he had not received a T4 form from Rato he could omit that income from his return. The remaining understatement for 1989 is in two parts. J find that the Appellant knew very well that he had received payments from the company, and at the least this knowledge was such as to require that he make some inquiry as to the finances of the business before filing a return certifying that he had no income from it during the year. There were statements available by the end of January 1990 which, had he made the inquiry, would have revealed the income in the amount of $7,134.51 in respect of which he was later convicted.

The remainder of the undeclared income for 1989, and that for 1991 and 1992, is the result of the scheme to disguise sales revenues as loan advances, or for 1989 more accurately capital contributed. He maintained in his evidence that he paid no attention to the writing on the deposit slips. He said that it was all being done by his brother without his knowledge, and that he had neither the time nor the financial acumen to find out about it. He simply trusted his brother. I think it unlikely that he had no idea what was going on. The Appellant took the deposits of these amounts to the bank on numerous occasions. It seems incredible that he would not have read the notations on the deposit slips, and then inquired of his brother why the amounts were being treated as loans. Certainly, he did from time to time advance amounts to the business, which he raised by way of mortgages on his house. He must have known, though, that the sums he was depositing did not come from those loans. Neither the timing nor the amounts would have coincided.

Significantly, Mr. Schell was able to compare the amounts which were credited to the Appellant’s loan account and his drawings for the years 1990, 1991, and 1992. There is a high correlation between the amounts that were deposited under the guise of loans to the company, and the amounts of his drawings during those years. I have no doubt that the Appellant’s brother was the author of the scheme. However, these factors lead me to believe that the Appellant had good reason to suspect that things were not being done as they should be, and that inquiry on his part might bring him knowledge that he did not wish to have.

In the criminal law, wilful blindness equates to knowledge sufficient to establish mens rea.’ [7] The test to be applied was set out there by Sopinka J.: [8]

A finding of wilful blindness involves an affirmative answer to the question: Did the accused shut his eyes because he knew or strongly suspected that looking would fix him with knowledge?

In my view, the answer to that question in the present case is affirmative.

The Crown pleaded in the alternative that the Appellant is liable in any event to penalties for the years 1991 and 1992 under subsection 163(1). It reads:

163 (1) Every person who

(a) fails to report an amount required to be included in computing the person’s income in a return filed under section 150 for a taxation year, and

(b) had failed to report an amount required to be so included in any return filed under section 150 for any of the three preceding taxation years

is liable to a penalty equal to 10% of the amount described in paragraph (a), except where the person is liable to a penalty under subsection (2) in respect of that amount.

There is no question that the Appellant failed to report an amount in 1989. 1991 and 1992 are both within three years of 1989. If I were wrong in my conclusion as to the penalties under subsection 163(2) for 1991 and 1992, the Appellant would nevertheless be liable under subsection 163(1). For both years the 10% penalty under subsection (1) is greater than the penalties which were assessed under subsection (2). The appeals of the penalties for those two years must therefore fail, regardless of the Appellant’s state of mind or degree of negligence.

The appeals are dismissed, with costs.

Appeal dismissed.