Henk Brouwer v. Minister of National Revenue, [1979] CTC 2219, 79 DTC 235

M J Bonner:—This is an appeal from an assessment of income tax and penalty for the appellant’s 1972 taxation year. Notice of the assessment was dated July 22, 1975. In computing income the Respondent included, pursuant to subsection 15(1) of the Income Tax Act, the sum of $25,882.23 described in the form T7W attached to the notice of assessment as “Accounts receivable (Otten)”. The T7W stated as well that a penalty had been imposed under subsection 163(2) of the Act and that the penalty was applicable only to “additional tax resulting from the investigation”.

The appellant’s position with respect to the inclusion was that the Minister had proceeded on the basis that the appellant had appropriated an account receivable belonging to a company of which the appellant was the sole shareholder. The appellant argued that the account receivable remained, at all times, the property of the company, was never assigned to the appellant, and was ultimately collected by the company. Accordingly, the appellant argued that the inclusion in income and penalty consequent thereon should be set aside.

There were other issues raised by the notice of appeal and reply to which I will make reference later.

The name of the appellant’s company was Henk Brouwer Construction Limited. It carried on the business of framing and concrete work.

The appellant’s brother-in-law, Arend Otten, was a farmer. Mr Otten gave evidence. In 1971 the appellant and Mr Otten discussed the erection of a barn on Mr Otten’s farm and the digging of two ponds. The works were required to enable Mr Otten to commence a veal calf raising operation. It was planned that the appellant would become Mr Otten’s “partner” in that operation. The appellant’s contribution, according to Mr Otten, was the erection of the barn and the digging of the ponds . . in such a way that it would not be paid for right away”.

The barn was constructed by the company in late 1971 and was completely finished in January or February of 1972. A financial statement prepared by Mr Otten, Exhibit R-1, listing the cost of the assets of the veal calf operation showed total costs of $84,373.40, of which the cost of the barn and ponds were $23,369.23 and $2,513 respectively. An entry in those records stated “Henk Brouwer shares—$25,500 or 30%’’. When questioned about this entry Mr Otten indicated that he was not certain whether he was dealing with the company or with the appellant.

On December 28, 1972, Mrs Otten prepared a document, Exhibit A-1, Stating in part as follows:

The $4,270.83 was paid by cheque dated December 28, 1972, drawn by Mrs Otten in favour of “Brouwer Construction Ltd”. The $382.23 was paid to round the total figure of $25,882.23 down to $25,500. The “share of the profit” was paid in fulfillment of an agreement to pay 30% of the profit from the veal calf raising operation and the $1,785 was paid pursuant to an agree- ment to pay 7% interest. Both were payable, according to Mr Otten, so long as the $25,500 debt was outstanding.

An invoice dated February 2, 1972, from “H Brouwer Construction Ltd” to Mr Otten regarding the construction of a new barn (at a figure of $19,200) and remodelling of an old barn) at a figure of $2,800) was issued bearing the endorsement “Paid in full March 2,1972—H M Brouwer”. Mr Otten admitted that although he had not paid this amount he asked for a receipt because a government grant was available to ‘‘a farmer who spent money” and he had to have proof of payment.

Ronald Scott, a chartered accountant who at all relevant times practised his profession in St Catharines, gave evidence. On December 10, 1971, Mr Scott commenced to act for the appellant and the company. His firm prepared the appellant’s 1971 and 1972 personal income tax returns, and as well the income tax returns of the company for the fiscal period ending April 30,1972, and later years. Those returns were prepared on the basis of information supplied to Mr Scott or members of his staff by the appellant. Mr Scott’s firm did not perform an audit function.

The appellant’s 1972 tax return disclosed:

The company, in its 1972 return, did not record any amount receivable in respect of the Otten farm work, but it did include in the expenses claimed the cost of the Otten barn and ponds. That cost was $25,882.23.

Before preparing the 1972 return of the company Mr Scott obtained a list of accounts receivable of the company for that fiscal period. Mr Scott testified that he thought the information was obtained from the appellant’s wife. The working papers prepared by Mr Scott listing the receivables did not include any amount in respect of the Otten work.

Mr Scott did not become aware of the Otten transaction until June or July of 1973 at a meeting of Mr Secord, an officer of the Department of National Revenue, and Mr Scott and Mr Brouwer. The irregularities came to light as the result of an initiative taken by the respondent. Mr Scott was cross- examined on certain notes, Exhibit R-10, prepared at the time of preliminary discussions in relation to the Revenue investigation. At that time he was under the impression that the cost of the barn and ponds had been borne by the appellant personally. Although Mr Scott did not remember that the appellant told him that such was the case, he admitted that his only source of information was the appellant.

The $4,270.83 cheque from Mrs Otten to the company was deposited in the company bank account on January 12, 1973. The amount was, however, eliminated from the revenue of the company by journal entry made in the general ledger as of April 30, 1973. $1,785 was credited to interest income and the remainder was credited to the appelant’s loan account. Mr Scott explained that an error was made at his office in crediting the $382.23 part of the total Otten payment, relating to the cost of the barn, to the appellant’s loan account. The entries mentioned in this paragraph reflect the conclusion ultimately reached by Mr Scott that there were two transactions; (a) the company built the barn and was entitled to receive the cost of that work and the interest on the balance outstanding, and (b) the appellant was entitled to the 30% share of profit from the veal calf operation.

The $25,882.23 was reported as income by the company in 1973. I very much doubt that this was the proper year in which to report the income, but in any event that question is not before me.

The appellant was not called to give evidence. The respondent called no evidence.

The appellant argued that the single issue is whether an account receivable was appropriated by the appellant. He pointed out that the respondent had, in the reply, admitted that . . an account receivable of $25,882.23 arose when Henk Brouwer Construction Limited performed a construction contract for Mr Arend Otten”. The appellant argued as well that, as noted above, there are only two ways in which an account receivable can be appropriated, namely, by receipt of payment or by assignment of the chose in action. Neither of those steps had been taken and accordingly, so the appellant argued, the inclusion in income and the penalty levied thereon was wrong.

The respondent argued that what was appropriated was the value of the work done, namely, the agreed investment in the veal calf operation. He submitted that the appellant should be regarded as having appropriated that value because the appellant had invested it in the veal calf venture and had appropriated the proceeds of the venture, namely, the interest and the 30% share of profit. Further, the argument went, the appellant had caused the company to fail to record the receivable. The respondent relied on the decision of the Ontario Court of Appeal in The Queen v Fred E Poynton, [1972] CTC 411; 72 DTC 6329, and argued that use and enjoyment by the appellant of the benefits flowing from the receivable was sufficient to bring the case within subsection 15(1), even though the property in the receivable remained with the company.

It is clear that during the 1972 fiscal period the company did, at its expense, erect a barn and dig ponds as a result of an agreement between the appellant and Mr Otten. It is not at all clear, on the facts before me, whether the arrangement was made between Mr Otten and the appellant on behalf of the company or between him and the appellant in his personal capacity. However, the admission made in the reply requires that the case be approached as one in which the Otten farm work gave rise to a receivable from Mr Otten, which receivable was the property of the company. The case cannot be approached as one in which the company did the work at the behest of the appellant and not in fulfillment of a contract in which there was privity between Mr Otten and the company.

I do not read the Poynton decision as authority for the proposition that an incomplete attempt to steal property gives rise to liability for tax on the value of the property in question. The evidence here discloses an attempt by the appellant to appropriate the company’s receivable from Otten. The appellant accomplished only a temporary diversion of the annual benefits accruing from the Otten transaction. The appellant was not successful in his attempt to appropriate the account receivable. It was initially and remained the property of the company. The appellant must therefore succeed on this branch of the appeal, both with respect to the inclusion and with respect to the penalty levied thereon.

The pleadings raised issues relating to a number of other amounts which were not reported by the appellant and which were included by the respondent in computing the appellant’s income for the year. Penalties were levied thereon pursuant to subsection 163(2) of the Act. No evidence was led by either party in relation to these issues. The appellant has therefore failed to establish that the inclusions were incorrect. The respondent argued that, having regard to the magnitude of the amounts, the failure to report the income must have been deliberate, or at least must have taken place in circumstances amounting to gross negligence. Under subsection 163(3) the burden with respect to penalties is on the respondent. All I have before me is a case of simple failure, in unexplained circumstances, to report amounts of income, the nature of which is not disclosed by the evidence. That failure, without more, is not a sufficient factor on which to uphold the penalty.

The appeal will therefore be allowed and the assessment for the appellant’s 1972 taxation year will be referred back to the respondent for reconsideration and reassessment on the basis that: (a) there is to he excluded in the computation of the appellant’s income the sum of $25,882.23 in respect of the Otten receivable, (b) all other inclusions in income to which reference was made in the notice of appeal will remain undisturbed, and (c) the appellant is not liable to penalty on the amounts to which reference is made in paragraph 6(e) of the reply.

Appeal allowed.