Gray v. R., [1998] 4 CTC 2040

McArthur T.C.J.:

This appeal is from a reassessment made under the Income Tax Act for the Appellant’s 1990 taxation year. Essentially two issues are raised:

a) Was the Minister of National Revenue correct in adding the sum of $403,103.85 to the Appellant’s taxable income for the 1990 taxation year following a “net worth” assessment?

b) Was the Minister justified in assessing penalties under subsection 163(2) of the Income Tax Act?

The Appellant’s counsel introduced a procedural issue at the opening of trial. Since the Minister assessed four prior years up to December 31, 1989 beyond the three-year period from the date of mailing of the notice of the original assessment, the onus was upon the Respondent to establish that the Appellant had made a misrepresentation as described in subparagraph 152(4)(a)(i).

Relying on the reasoning of Bowman, T.C.C.J. in Farm Business Consultants Inc. v. R. (1994), 95 D.T.C. 200 (T.C.C.), I agreed that with respect to the years alleged to be statute-barred, the Respondent should present evidence and argument first to establish the Minister’s right to assess those years. Counsel for the Respondent then advised that he consented to judgment with respect to the years 1986, 1987, 1988 and 1989.

Auditors for Revenue Canada concluded that the understated amount in 1990 was accounted for by a bank deposit to the Appellant’s account with the Royal Bank of Canada in Ottawa, originating from a bank in Switzerland in the amount of $449,990.

The Appellant denies the Respondent’s position that the bank deposit originating from Switzerland had as its source a business of the Appellant. The Appellant’s position is that he borrowed the amount from Franz Gahwiler, an apparently wealthy businessman in Zurich, Switzerland.

Facts

A determination of the question before the Court depends on the interpretation of the facts. The Appellant is 47 years of age and has university degrees from Waterloo and Cambridge. He has been engaged in the high technology business since the early 19803. In 1983, while working for Mitel Corporation, he met Franz Gahwiler at a trade show in Geneva, from whom he later borrowed money. Mr. Gahwiler died in March 1994. In about 1984, the Appellant, together with Gordon G. Buchan started the corporation Omzig. Omzig worked on a prototype for electronic mail. Once the prototype was completed the Appellant aggressively sought adventure capital financing. He personally borrowed in excess of $400,000 from Franz Gahwiler in the late 1980s, all of which appears to have been repaid through deposits to the credit of a Swiss bank (Credit Suisse) with no other identification or information.

While Omzig made money in 1987, it ceased operating in 1988 primarily because of the market preference for faxed information over E-mail. The Appellant retained Omzig’s developed source code or technology. The Appellant continued with the development of this technology through a second corporation Intelligent Control Systems Laboratory Inc. (ICSL).

Omzig Sa Fribourg (revisuisse) was incorporated in Switzerland in about 1985, a wholly owned subsidiary of Omzig. It never operated as an income-producing company.

In December 1990, the Appellant received the sum of $450,000 Canadian funds directly from a bank in Switzerland (Credit Suisse). He used the funds, together with $170,000 borrowed from the Royal Bank of Canada in Ottawa to purchase a home in Nepean for $620,000.

The Respondent’s position is that $450,000 of this money had as its source a business or investment of the Appellant.

In support of his position, the Appellant submitted:

a) a Promissory Note for $450,000 at 5% interest from himself to Franz Gahwiler dated December 15, 1990:

b) a Memorandum of Understanding dated December 1, 1990, wherein Franz Gahwiler appears to purchase rights to certain products in the fields of telex and electronic mail;

c) a copy of an Affidavit of Franz Gahwiler to be dealt with later;

d) a fax letter from Mr. Gahwiler.

e) A License Agreement dated September 28, 1992, wherein Mr. Gahwiler purchased certain rights from the Appellant for $500,000 and subsequently, the Appellant states that he paid Mr. Gahwiler the $450,000 plus interest borrowed on December 1, 1990;

f) a death certificate stating Mr. Gahwiler died on March 11, 1994;

g) Remuneration Agreement - between Omzig and the Appellant;

h) three witnesses: 1) L. Tremblay, accountant for Omzig; 2) accountant for the Appellant and ICSL; and 3) G. Buchan, former co-owner of Omzig.

I will now deal with the Affidavit. It has the outward appearance of authenticity and reads as follows:

Affidavit

I, Franz Gahwiler, Business Executive, of Walde, Switzerland hereby give the following information in respect of an investigation by Revenue Canada, Taxa- tion into the past business dealings I have had with Glen R.H. Gray of Ottawa, Ontario, Canada:

1. I have made the following four (4) loans to Glen R.H. Gray:

a) August 15th, 1986 for the amount of CAD 150’000.00

b) November 1st, 1986 for the amount of CAD 200’000.00

c) January 7th, 1989 for the amount of CAD 100’000.00

d) December 15th, 1990 for the amount of CAD 450’000.00

2. The first three loans were made to Mr. Gray on the security of his common

shares of Omzig Corporation and individual promissory notes signed by him, and delivered to my agent Reza Parsa.

The final loan was made to Mr. Gray on the security of all outstanding shares of Intelligent Control Systems Laboratory Inc. and a promissory note signed by him.

3. All funds provided to Mr. Gray were from funds at my discretion.

4. The loans to Mr. Gray were made out of accounts at Credit Suisse,

Zürich.

5. My records indicate that Mr. Gray has repaid all the loans and associated

interest to me on the following basis:

1986	CAD	2,000.00
1987 CAD 15,000.00 +			USD	10,000.00
1988	CAD	354,500.00
1989	CAD	157,500.00
1991	CAD	22,500.00
1992	CAD	468,750.00

6. At the present time, no loans are outstanding to Mr. Gray.

7. All notes were payable on demand and were interest bearing.

8. All loans were negotiated in Canadian Dollars.

9. I can be reached during normal business hours at

Franz Gähwiler

Schiltwald 190

Postfach 20

CH-5047 Walde

Switzerland

telephone (064) 83 25 65

And I have signed

Franz Gahwiler

Official Certification

Seen for authentication of the above signature, affixed in our presence by Mr. Franz Bernhard Gähwiler, born the 25 of July 1944, Swiss citizen of Zurich and Mogelsberg SG, residing at Schilwald 190, 5047 Walde (Schmiedrued), who has identified himself by identifiedcard,

Zurich, this 19 day of May 1993

B no. 1090

Fee: Fr. 10.-

The Appellant submits that its contents be accepted as fact and referred to sections 53 and 54 of the Canada Evidence Act. The Respondent argues that sections 53 and 54 were added in 1994 and do not apply to the 1993 document and that Mr. Gâhwiler is not present to be cross-examined. The sections read as follows:

53. Oaths, affidavits, solemn affirmations or declarations administered, taken or received outside Canada by any person mentioned in section 52 are as valid and effectual and are of the like force and effect to all intents and purposes as if they had been administered, taken or received in Canada by a person authorized to administer, take or receive oaths, affidavits, solemn affirmations or declarations therein that are valid and effectual under this Act.

54. Any document that purports to have affixed, impressed or subscribed thereon or thereto the signature of any person authorized by this Part to administer, take or receive oaths, affidavits, solemn affirmations or declarations, together with his seal or with the seal or stamp of his office, or the office to which he is attached, in testimony of any oath, affidavit, solemn affirmation or declaration being administered, taken or received by him, shall be admitted in evidence, without proof of the seal or stamp or of his signature or official character.

Subsequent to receipt of the document, a German-speaking Revenue Canada employee spoke to Mr. Gâhwiler by long distance telephone. Mr. Gâhwiler requested that any questions they wished to have answered be faxed to him in writing. Ten questions were faxed to him September 2, 1993. His faxed reply dated September 8, 1993 (Exhibit A-10) stated in part:

For the above reasons you must be content with the affidavit which I sent to Mr. Gray.

As citizen of Switzerland, I am not prepared to inform foreign authorities about my relationship to foreign citizens except in situations where there is reason to suspect that they may have committed unlawful acts in Switzerland.

I regret that I am unable to give you a more favourable response and I remain with best regards

Franz Gähwiler

signed

Translated by K. Weiser

Revenue Canada

Sept. 8, 1993

tel 598-4118

The Revenue Canada auditors testified that the Appellant originally advised them he had received the money from Reza Parsa, a European investor. However, as they pursued the matter, the Appellant came forth with the Promissory Note, Agreements and Affidavit, all from Franz Gâhwiler (translated from German to English).

In reply to the Respondent’s submissions the Appellant called three witnesses:

a) Laurent Tremblay, chartered accountant, who had been employed by Omzig from 1987 to 1990, was responsible for the accounting functions. He stated that the Appellant had consulted him in 1989 with respect to tax deductibility from interest to be sent overseas because he had borrowed money from a friend in Switzerland.

b) James S. McIntyre, chartered accountant, whose firm prepared Mr. Gray’s income tax returns for the past ten years. Much of his evidence was hearsay and of little assistance. He introduced financial statements for ICSL for years end January 31, 1991 and January 31, 1992.

c) Gordon G. Buchan, a practicing Ottawa lawyer, stated in part in a letter filed in evidence as exhibit A-19:

the exact amounts of the loans, I was present with Mr. Gray and Mr. Gahwiler on several occasions during which Mr. Gahwiler interest in investing in Omzig Corporation and the status of the loans was discussed.

6. The security for these loans were the Omzig shares owned by Mr. Gray. I understand that a Promissory Note was signed by Mr. Gray.

The Respondent filed as Exhibit R-l, the only banking documents evidencing the loan and repayment:

90 SPARKS STREET

OTTAWA, ONT.

	90 SPARKS STREET
	OTTAWA, ONT.
THE ROYAL BANK OF CANADA		18-12-1990
Account Number 770-621-1
B/O - Credit Swiss - Zurich
	G. Gray
	TOTAL	$449,990.00
‘GLEN GRAY
9 LOCH ISLE ROAD
NEPEAN, ONTARIO K2H 8G5		Oct. 15, 1992
PAY TO	Credit Suisse	$242,812.50

Two hundred and forty-two thousand, eight hundred and twelve 50/DOLLARS

ROYAL BANK OF CANADA
SPARKS AND METCALFE
90 SPARKS STREET
OTTAWA, ONT. KIP 5T6
MEMO	loan repayment	signed Glen Gray
‘GLEN GRAY
9 LOCH ISLE ROAD
NEPEAN, ONTARIO K2H SGS		Nov. 15, 1992
PAY TO	Credit Suisse	$225,937.50

Two hundred and twenty-five thousand nine hundred and thirty-seven 50/DOL

LARS
ROYAL BANK OF CANADA
SPARKS AND METCALFE
90 SPARKS STREET
OTTAWA, ONT. KIP 5T6
MEMO	loan repayment	signed Glen Gray

Position of the Respondent

The Appellant was not open and straightforward during the audit investigation and Revenue Canada concluded that the documentation was insufficient and suspect and that arm’s length businessmen do not lend substantial money in this manner. There was no proper audit trail. The security for the $450,000 was at best the shares of ICSL and a personal promissory note. The auditors concluded that it is not reasonable that the Appellant, in 1990, who was earning less than $55,000 annually, while trying to build a new company (ICSL) would borrow $450,000 to purchase a $620,000 home to which he added $75,000 in repairs and repay the money in 1992. Revenue Canada concluded that the money deposited in his personal account was unreported revenue of the Appellant held on deposit in a Swiss bank and brought into Canada to pay for his house. The money was returned to the Swiss bank in 1992 when he sold technology.

Observations

I note that the Appellant did not file returns for 1987 and 1988 until the tax department urged him to do so. I believe the auditing department would not have recommended the present assessment had the Appellant been straightforward and accommodating from the outset of the audit. Mr. Gâhwiler’s name was not mentioned, nor were most documents produced until the audit had been well underway. The Appellant stated that Mr. Gâhwiler was very private concerning his business matters and he was somewhat evasive with the auditors at the outset because he wanted to protect Mr. Gahwiler’s privacy. It is understandable that Revenue Canada assessed the Appellant as they did.

Analysis

The question boils down to one of credibility. Do I believe Mr. Gray? Given all of the surrounding circumstances, documents and evidence of his witnesses, I accept his evidence. The Appellant appears to have been very casual with his record-keeping but this does not undermine his credibility.

Mr. Tremblay, chartered accountant, Mr. McIntyre, chartered accountant and Mr. Buchan, L.L.B., Bar of Ontario were perfectly credible witnesses. Mr. Tremblay stated that the Appellant had indicated in 1989 that he had borrowed funds from a friend in Switzerland and questioned Mr. Tremblay with regard to withholding tax. This is consistent with the Appellant’s evidence.

Mr. McIntyre indicated that he had been advised by the Appellant over the years that he had borrowed $450,000 from Mr. Gâhwiler in consideration for certain license technology for which Mr. Gâhwiler agreed to pay and did pay $500,000 in September 1992.

Mr. Buchan testified that he was aware, in generality, that the Appellant had borrowed money from Mr. Gâhwiler and he opined that the Appellant’s integrity and honesty were without question. Mr. Buchan, during the 1980s, met Mr. Gähwiler several times in Ottawa during his visits with the Appellant. Mr. Buchan stated further that he is familiar with high technology business transactions and it is not unusual to borrow substantial funds under circumstances as exist in this appeal.

While Mr. Gâhwiler could not be cross-examined on his Affidavit, it cannot be simply ignored. On or about September 2, 1993, a Revenue Canada employee spoke to Mr. Gâhwiler concerning his Affidavit and he did not deny it. In fact, in his fax of September 8, 1993 he acknowledged his Affidavit. The Respondent does not deny that Mr. Gâhwiler did exist and that he died in March 1994. I am satisfied that Mr. Gâhwiler did sign the Affidavit as reproduced in this judgment.

I accept the authenticity documents submitted, in particular the Affidavit of Mr. Gâhwiler, the Memorandum of Understanding, the Promissory Note and the License Agreement. To do otherwise, I would have to assume that Mr. Gâhwiler and Mr. Gray were engaged in a conspiracy to create an agreement that did not exist to assist Mr. Gray in defrauding Revenue Canada. There is no basis for doing that.

There was no evidence of a source of the $450,000 other than from Mr. Gâhwiler. One of the assumptions the Respondent relied on in assessing the Appellant was that the bank deposits originating from Switzerland had as their source a business or investments of the Appellant. The Appellant successfully demolished this assumption. It is clear that the Swiss subsidiary remained basically inactive from the date of its incorporation.

Having found in favour of the Appellant in the first issue there is no need to deal with the question of penalties.

The appeal is allowed and the assessments are referred back to the Minister of National Revenue from reconsideration and reassessment. In light of the evasive actions of the Appellant with Revenue Canada, Auditing Division, no costs are awarded.

Appeal allowed.