Scherbakov v. R., [1999] 4 CTC 2073 (Informal Procedure)

Watson D.]. T . C.:

This appeal was heard in Edmonton, Alberta on June 1, 1999, under the Informal Procedure.

In filing his income tax returns for 1992, 1993 and 1994, the Appellant declared a total income of $15,303, $16,259 and $24,876 respectively. In reassessing the Appellant for these years, the Minister of National Revenue (the “Minister”) increased the total as follows:

Schedule A

Dimitri Sherbakov

Net Worth Discrepancy:

	1992		1993	1994
Adjusted Net Worth Discrep
ancy per Schedule B2	$71,087.06		$13,455.37	$75,831.15
Less amounts received as a
result of expenses reimbursed
by Trak Reforestation Inc.	12,300.00		4,800.00	4,800.00
Less capital outlays for farm,
previously expensed	7,622.00		321.00	-
Unexplained Net Worth Dis
crepancy as a result of em-
ployment/self-employment,
as determined by the audi
tor	51,165.06		8,334.37	71,031.15
Decrease to Total Income as
agreed upon during review of
the first Notice of Objection,
as per Schedule B3	( 24,973.01)	(	4,477.00)	( 17,884.03)

Net Worth Discrepancy:

	1992	1993	1994
Revised Increase to Total
Income, as agreed during
review of the original Notice
of Objection	26,192.05	3,857.37	53,147.12
Total Income Reported as	15,303.00	16,259.00	24,876.00
filed
Total Income from all sources	41,495.05	20,116.37	78,023.12
Income inclusion due to ex
penses reimbursed by Trak
Reforestation Inc.	12,300.00	4,800.00	4,800.00
Add back capital outlays to	7,622.00	321.00	-
farming operation
Total amount added to In-	19,922.00	5,121.00	4,800.00
come
Revised Total Income	$61,417.05	$25,237.37	$82,823.12

In so reassessing the Appellant, the Minister made the following assumptions of fact:

(a) at all relevant times, the Appellant owned 50% of the shares of Trak Reforestation Inc. (“Trak”);

(b) at all relevant times, Trak was engaged in logging operations;

(c) at all relevant times, the Appellant was an employee of Trak;

(d) in the 1992, 1993 and 1994 taxation years, the Appellant received reimbursements from Trak for amounts paid by the Appellant on behalf of Trak (the “Reimbursements”);

(e) the Reimbursements were deducted by Trak against its income as automotive and travel expenses;

(f) the expenses of Trak in respect of the Reimbursements were also deducted by the Appellant against his income from self-employment;

(g) in the 1992, 1993 and 1994 taxation years, the Reimbursements from Trak were $12,300, $4,800 and $4,800 respectively;

(h) Trak was the source of the self-employment income reported by the Appellant in the 1992, 1993 and 1994 taxation years;

(i) in receiving the Reimbursements, and then deducting those same amounts from self-employment income, the Appellant received benefits from Trak in the amounts stated in subparagraph (g) herein (the “Benefits”), in his capacity as a shareholder of Trak, or alternatively, in his capacity as an employee of Trak;

(j) in reporting his income for the 1992, 1993 and 1994 taxation years, the Appellant failed to report the Benefits;

(k) in the 1992, 1993 and 1994 taxation years, the Appellant owned and operated a farm in the vicinity of Plamondon, Alberta;

(l) in reporting income for the 1992 and 1993 taxation years, the Appellant deducted amounts totalling $7,622 and $321 respectively arising from capital outlays (the “Capital Outlays”) with respect to the farm operation;

(m) the Minister disallowed the deduction of the Capital Outlays from farming income;

(n) the Minister added the cost of the Capital Outlays to the capital cost of farming assets used by the Appellant to earn farming income;

(o) the Minister adjusted capital cost allowance in the 1992, 1993 and 1994 taxation years as a result of reclassifying the Capital Outlays, as shown in Schedule C;

(p) the income of the Appellant, from all sources, for the 1992, 1993 and 1994 taxation years was understated by the amounts of $26,192.05, $3,857.37 and $53,147.12 respectively;

(q) the income of the Appellant in the 1992, 1993 and 1994 taxation years from all sources was $41,495.05, $20,116.37 and $78,023.12 respectively;

(r) in reporting income for the 1992, 1993 and 1994 taxation years the Appellant did not include all of the income received in those years:

(s) at all relevant times, the Appellant failed to maintain proper books and records for the farming and logging operations; and

(t) the understated amounts referred to in subparagraph 6(p) herein were determined by the net worth method (a copy of the Statement of Personal Net Worth is attached as Schedules “Bl to B3”).

At the hearing of the appeal, the agent for the Appellant admitted paragraphs (a), (d) to (g), (k) to (o), (s) and (t) and denied paragraphs (b), (c), (h) to (j) and (p) to (r). The Minister relies on section 3, subsections 9(1), 15(1), 152(4) and 152(7), paragraphs 6( 1 )(rz), 18(1)(b) and 20(1 )(rz) of the Income Tax Act (the “Act”) and on Parts XI and XVII of the Income Tax Regulations (the “Regulations”) and submits from the Reply to Notice of Appeal:

9. ...that, in the 1992, 1993 and 1994 taxation years, the Appellant, in his capacity as shareholder of Trak, received the Benefits from Trak, and that these Benefits were properly included in his income by the Minister pursuant to section 3 and subsection 15(1) of the Act.

10. In the alternative, he submits that the Benefits were received in the Appellant’s capacity as employee of Trak in the 1992, 1993 and 1994 taxation years and that the Benefits were properly included in his income pursuant to section 3 and paragraph 6( 1 )(a) of the Act.

1 1. He further submits that the Appellant understated his income from

farming in the 1992 and 1993 taxation years by deducting Capital Outlays from his income, which amounts are not deductible pursuant to paragraph 18(1)(b) of the Act, but form part of the basis for the calculation of capital cost allowance pursuant to paragraph 20(1)0) of the Act and Parts XI and XVII of the Regulations.

12. He further submits that the Appellant understated his income from all sources for the 1992, 1993 and 1994 taxation years by the amounts of $26,192.05, $3,857.37, and $53,147.12 respectively, as determined by the net worth method and shown in the attached Schedules. He submits that these amounts were properly included in the income of the Appellant in the 1992, 1993 and 1994 taxation years pursuant to section 3 and subsections 9(1), 152(4) and 152(7) of the Act.

The issues to be decided from paragraph 7 of the Reply to Notice of Appeal are:

(a) whether the Appellant received the Benefits in his capacity as shareholder of Trak, or, alternatively, in his capacity as employee of Trak, in the 1992, 1993 and 1994 taxation years;

(b) whether the Capital Outlays are deductible, or expenditures or outlays on account of capital in the 1992 and 1993 taxation years; and,

(c) whether the Appellant’s income, from all sources, for the 1992, 1993 and 1994 taxation years was understated by the amounts of $26,192.05, $3,857.37 and $53,147.12 respectively.

The Appellant has the onus of establishing on a balance of probabilities that the Minister’s reassessment is ill-founded in fact and in law; he must adduce sufficient or reliable evidence justifying a conclusion that he has, on a balance of probabilities, shown an error on the part of the Minister.

Bowman, J. of this Court, in the case of Ramey v. R. (1993), 93 D.T.C. 791 (T.C.C.) at p. 793 stated as follows:

... Fhe net worth method of estimating income is an unsatisfactory and imprecise way of determining a taxpayer’s income for the year. It is a blunt instrument of which the Minister must avail himself as a last resort. A net worth assessment involves a comparison of a taxpayer’s net worth, i.e., the cost of his assets less his liabilities, at the beginning of a year, with his net worth at the end of the year. To the difference so determined there are added his expenditures in the year. The resulting figure is assumed to be his income unless the taxpayer establishes the contrary. Such assessments may be inaccurate within a range of inde- terminate magnitude but unless they are shown to be wrong they stand. It is almost impossible to challenge such assessments piecemeal. The only truly effective way of disputing them is by means of a complete reconstruction of a taxpayer’s income for the year.

In the case of Zalzalah v. R. (1994), 95 D.T.C. 5498 (Fed. T.D.), Heald, D.J. states at p. 5499:

The plaintiff frankly acknowledged that he did not keep any books or records during the taxation years here under review. This matter was also raised in the proceedings before the Tax Court of Canada where Lamarre Proulx, TCJ stated^ [1]

The Minister cannot and should not allow business deductions that cannot be proven by documentary evidence. That would bring the administration of the Income Tax Act in the sphere of arbitrariness.

I agree with that view of the matter. Likewise, in the case of Holotnak v. The Queen,! [2] Cullen, J. considered the requirements of section 230 and stated as follows:

Section 230 of the Act requires taxpayers to keep adequate books and records. “Adequate” is not defined but it would seem that these records should support whatever the taxpayer is claiming for tax purposes.

The onus of proof that the expenses were incurred for the purpose of earning income is on the taxpayer (Wellington Hotel Holdings Limited v. M.N.R., 73 D.T.C. 5391). Specifically, with regard to assessments, the onus is on the taxpayer to prove that the Minister’s assumptions and assessments are wrong (Strayer, J. in Schwarz v. The Queen, 87 D.T.C. 5274) quoting from Johnston v. M.N.R., [3 DTC 1182] [1948] S.C.R. 486). The Schwarz case (supra) also involved a situation where the plaintiff’s purchases were not supported by vouchers. As Strayer, J. points out, the onus is on the taxpayer to prove wrong the M.N.R.’s reassessment as the taxpayer is in a better position to prove what actually happened.

The Appellant had three sources of income in the years at issue as follows: Trak a small family owned enterprise, co-owned by himself and Feoktist Semerikov, his brother-in-law, which operated on a seasonal basis from May I to mid-November planting and spacing trees on reforestation contracts for the Government; a logging operation from mid-November to April, carried on in partnership with his father and two brothers; and his 100 acre farm located in a small religious community approximately eight miles from Plamondon, Alberta.

The Appellant left school at the age of 14 to work on the family farm; because of his limited education, he left all the books, records and accounts with his accountants. There were two separate accountants, one looking after Trak and the other, his personal finances and his partnership dealings. He would keep notes when he spent his own personal funds on Trak or partnership matters and hand them over to the accountants; he kept no records or documents himself.

Insofar as Trak was concerned, both he and Feoktist would frequently inject personal funds into the company to cover its expenses and then rely on later being reimbursed; any notes taken were handed over to the accountant. This happened frequently because Trak operated in isolated areas and had from 10 to 30 employees at any given time. Both of them drew funds from the Company’s bank account as needed to cover both business expenses and personal living expenses for himself and family.

Insofar as the partnership’s logging business was concerned, all four drew funds from the partnership’s bank account and advanced personal funds into the business when received. Again, the Appellant would make note of this and hand them over to the other accountant. The Appellant kept no personal record or documents relating to the amounts advanced to the partnership or the amounts spent on business or personal expenses.

In late 1995 or early 1996, when the Appellant was audited by Revenue Canada, he referred the auditor to his accountants for the information they needed. Later on, he changed accountants to Equity Tax Management in Edmonton, Alberta. At the hearing, there was no evidence from the previous accountants, books, ledgers or other supporting documentation provided by the Appellant. The testimony of the Appellant and his brother Platon was based on their memory of what happened in the three years at issue and, understandably, it was mostly vague and incomplete rather than reliable.

Taking into consideration all of the circumstances, including the testimony of the Appellant, his brother and Revenue Canada auditor, the admissions and documentary evidence provided by the Respondent in the light of the well established case law, I am satisfied that the Appellant has failed in his onus of establishing on a balance of probabilities that the Minister was ill-founded in fact and in law in his reassessment.

Accordingly the appeal is dismissed.

Appeal dismissed.