Date: 20030115
Docket: 2001-2406-IT-I
BETWEEN:
MARLENE FRANCISCO,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
____________________________________________________________________
Agent for the Appellant: Richard Kittar
Counsel for the Respondent: Lorraine Edinboro
___________________________________________________________________
Reasons for Judgment
(Delivered orally from the Bench
on December 13, 2002, at Toronto, Ontario)
Bowie J.
[1] Ms. Francisco appeals from assessments for income tax for the years 1992, 1993 and 1994. The 1992 and 1993 taxation years are statute-barred, and so the Respondent has the burden of proof for those years. 1994 is not statute-barred, and so the Appellant has the burden of proof for that year. Penalties under subsection 163(2) of the Income Tax Act (the Act) were applied for all years, and the Respondent has the burden of proof as to those: see subsection 163(3) of the Act.
[2] In 1992, and for some years before that, the Appellant was the sole shareholder of a company called Aurora Marine Industries Inc. She and Mr. Richard Kittar operated this business together during all of the time period that is relevant to these appeals. They also lived together as common-law spouses. Mr. Kittar became a shareholder in Aurora during 1994. He and the Appellant worked full-time to operate the business, but they took their remuneration in the form of management fees which were recorded at year end. Throughout the year, they drew from time to time against their separate loan accounts in order to meet their living expenses. They had no employment income or dividend income from Aurora, nor any other source of income. The Appellant declared income of $6,600 for 1992, $6,100 for 1993, $7,600 for 1994 and $7,937.50 for 1995. The amounts declared by Mr. Kittar were of the same approximate magnitude. Mr. Kittar explained that they took only these modest amounts for their efforts during the years in question because the poor economic conditions of the late 1980s and early 1990s had severely impacted the company through both reduced sales and bad debts that had to be absorbed.
[3] During 1997, the officials of Revenue Canada became suspicious that the Appellant and Mr. Kittar were not declaring all their income from Aurora, and so an audit was conducted during the latter part of 1997 and the first part of 1998. I should perhaps add that suspicion arose only out of the fact that the Appellant's income tax returns revealed the fact that she was claiming, for the purposes of the Ontario municipal taxation rebate legislation, to be paying rent which exceeded her annual income. So far as the evidence shows, there was no other reason to suspect any undeclared income.
[4] The audit was both lengthy and thorough. The Minister's auditors were unable to find any evidence in the books of Aurora of payments to the Appellant, or to Mr. Kittar, that were unaccounted for, but, still of the view that there was undeclared income, they proceeded to assess the incomes of the Appellant and Mr. Kittar by the net worth method. The reassessments of the Appellant from this process added significant amounts to her income for each year from 1992 to 1995. These amounts were reduced on objection, principally through the deletion of an item of personal expense which related to the maintenance of a boat. It was established at the objection process that this item was in fact a legitimate expense of the company. (The company manufactures and distributes boating supplies, the boat was used for the purpose of testing those supplies, and so it was appropriate that the company pay for the maintenance of it.)
[5] The impact of these reassessments of the Appellant can be shown in this way:
|
|
1992 |
1993 |
1994 |
1995 |
|
Income declared |
$ 6,600 |
$ 6,100 |
$ 7,600 |
$7,397.50 |
|
As reassessed after audit |
$25,155 |
$27,410 |
$19,415 |
$8,602.50 |
|
As reassessed after objection |
$19,674 |
$18,268 |
$13,160 |
$7,397.50 |
|
Allegedly unreported |
$13,074 |
$12,168 |
$ 5,560 |
-0- |
[6] One of Revenue Canada's assessors, Ms. DeGregorio, gave evidence as to the manner in which the net worth assessment calculations were carried out. She was clear and candid in giving her evidence, and I find it to be reliable.
[7] The net worth assessment process is simple in principle, but its application in practice is sometimes complex. It depends upon an ascertainment of the net worth of the taxpayer at the beginning and at the end of each assessment period, and an ascertainment of the taxpayer's consumption during the period. Consumption plus increase in net worth, or minus decrease in net worth, is assumed to be the income for the period, subject to adjustment for any windfall or non-income amounts such as inheritances or gambling winnings. The final estimate of income is, of course, no better or worse than the estimates that are made of the assets and liabilities of the taxpayer, and of the taxpayer's personal living expenses and other items of consumption.
[8] It is trite to say that the net worth method is one of last resort, applied where more conventional approaches cannot be used because of a lack of reliable records. It is used most frequently in situations where the taxpayer conducts a business that has many cash transactions and the business records are incomplete, non-existent or unreliable. In the present case, the Appellant was operating a business which had virtually no cash transactions. Its records were not incomplete, although I accept Ms. DeGregorio's evidence to the effect that the state of the books of Aurora made it difficult to be satisfied that all of the compensation had been properly recorded. The assessors had to make substantial adjustments to the two loan accounts of the Appellant and Mr. Kittar before the net worth process could begin. Nevertheless those adjustments were ones that they were able to make and it is not at all clear to me why the Minister felt it necessary to resort to the net worth method in the present case. It is, of course, open to the Minister to use the net worth method of assessment whenever he considers it appropriate: see subsection 152(7) of the Act.
[9] This method of assessment has been called a blunt instrument, and there is no question that the Minister in this case took a very blunt instrument to this Appellant. The assessors chose to compute the net worth assessment of the Appellant and of Mr. Kittar on a combined basis. Ms. DeGregorio said that this was done because they lived together and shared household expenses. Rather than do two computations of their incomes on an individual basis, attributing part of the personal living expenses to each of them, the assessments were made by combining the assets and the liabilities of Mr. Kittar and the Appellant at the end of each period, and using the change in their combined net worth, together with their combined personal living expenses, to produce an estimate of their combined incomes for each relevant year. Those estimates are:
|
1992 |
$25,891 |
|
1993 |
$24,438 |
|
1994 |
$23,038 |
From these were subtracted the sum of the declared incomes of the two individuals to produce an aggregate undeclared income for them both. These are:
|
1992 |
$13,074 |
|
1993 |
$12,168 |
|
1994 |
$ 7,414 |
[10] The final stage of the process was to allocate this between the two taxpayers. Ms. DeGregorio explained that for 1992 and 1993 the entire amount was allocated to the Appellant because she was the sole shareholder of Aurora, and it was assumed by the Minister that all of the income of both taxpayers came from Aurora. Indeed, that fact has not been ever put in doubt. For 1994, the combined allegedly understated income was prorated between the two taxpayers because Mr. Kittar became a shareholder during that year. Exactly how that was done was not made clear to me, but my impression was that all the 1994 allegedly undeclared income, up to the point when Mr. Kittar became a shareholder and one-half of it thereafter, was attributed to and assessed against the Appellant. In any event, 75 percent of the amount for 1994 is what was attributed to and assessed against the Appellant.
[11] There was much evidence and much debate directed to whether the assessor's estimate of living expenses for the taxpayers was accurate or reasonable, and there was a good deal of evidence as well about the state of the books of Aurora, and particularly the loan accounts of the taxpayers, and a loan account of Mr. Kittar's mother. I do not propose to deal with any of these matters because it is apparent to me that, no matter how accurately the living expenses may have been estimated, the appeals must succeed on other grounds.
[12] I shall deal first with the years 1992 and 1993 which are statute-barred. For those years the Minister has the onus of proving the unreported income alleged. If we assume for the sake of argument that the combined unreported income is correctly computed, and I want to emphasize that this is merely an assumption for the sake of argument and I make no finding, the onus remains on the Minister to establish what part of that unreported income was received by the Appellant.
[13] As I understood the Respondent's counsel, the argument is that as the Appellant controlled the company she must have received the unreported income. I do not accept that proposition. Each of the two taxpayers performed services for the company for which they were paid consulting fees. It is true that the Appellant was in a position to determine how much they would each be paid, as she owned all the shares. It does not follow, however, that she alone, or at all, received any unreported amounts. Indeed, it is theoretically possible, although I stress that there is no evidence of it, that Mr. Kittar could have helped himself to amounts that would account for all the unreported income without the Appellant ever having any knowledge of it. I say this not because I have any reason to believe that it happened, but simply to illustrate that the Minister has fallen far short of discharging the onus upon her. The appeals for 1992 and 1993 must succeed on that basis alone.
[14] However, there is a more fundamental reason why these assessments cannot stand. I shall deal with it in connection with the year 1994, but it has equal application to all the other years as well. I use 1994 because that is the year in which the onus is upon the Appellant, in the words of the Supreme Court of Canada, to demolish the Minister's assumptions on which the assessment is based. So far as that year is concerned, the core assumption is that in 1994 the Appellant understated her income by $5,560 and that this is established, and I quote here from the Minister's assumptions underlying the assessment as they are set out in paragraph 7 of the Reply to the Notice of Appeal:
(f) the Appellant's understated income amounts were determined by the net worth method as per Schedule "A" attached hereto.
Schedule "A" then is the fundamental underlying assumption.
[15] In my view, there is no validity to the methodology whereby a combined net worth assessment of the unreported income of two people is generated, and then some part attributed to each of them, thus requiring that they then individually disprove the amount that has been assessed against them. This is quickly demonstrated by looking at the asset section of the computation of the income by the net worth method that is Schedule "A" to the Reply to the Notice of Appeal. As an aside, I might note that that Schedule is a three-page document which, it is quite apparent, has been created by cutting and pasting parts of other documents, shrinking them on a photocopier at the same time, and making a photocopy which borders upon illegibility. And I might parenthetically note that it seems to me grossly unfair to produce that sort of document as the fundamental assumption underlying an allegation of undeclared income. The Deputy Attorney General of Canada has perhaps reached a new low in the quality of his pleading in this case.
[16] Returning to the net worth computation, it shows in the asset section that between 1991 and 1996 both Mr. Kittar and Ms. Francisco had positive balances in their shareholder loan accounts. Between the end of 1993 and the end of 1994 Ms. Francisco's loan account balance decreased from $11,812.50 to $3,862.50, or in other words by $7,950. During the same period, that is the year 1994, Mr. Kittar's balance increased by $953. There were a few other very small changes in the elements of their net worths, but for practical purposes those can be ignored. The decrease in their combined net worth, which the Minister computed to be $7,027.83, consists entirely of the decrease in the credit balance of the Appellant's loan account. The Minister goes on to conclude that their living expenses, which they paid jointly, net of the GST credits which they each received, were $30,066. Mr. Kittar reported income of $8,024, Ms. Francisco reported income of $7,600, a total of $15,624. The decrease in net worth was $7,027 for a total of $22,652. The Minister then concluded that between them the two individuals had underreported the difference between $22,652 and $30,066, which is $7,414.
[17] Clearly if the net worth calculation had been done separately for these two people, using the same numbers and allocating one-half of the living expenses to each of them, Mr. Kittar would have been found to have slightly more than $7,414 in unreported income, and Ms. Francisco would have been found to have overreported by a small amount, because her decline in net worth exceeds the unaccounted for amount by some $500, while Mr. Kittar had a slight increase in his net worth. To put it another way, by combining the net worth assessment process the Minister has given one-half the benefit of Ms. Francisco's decreased net worth to Mr. Kittar. It is obvious that, quite apart from any allocation problem that might arise at the end of the process, it can never be valid to combine the assets and the liabilities of two different taxpayers for the purpose of computing an estimate of their combined incomes because the effect is to assume, quite incorrectly, that any changes in the assets and any changes in the liabilities of either one of them during the period being assessed are shared between them. Without the need for the Appellant to lead any evidence at all, it is evident that the assessment done by this method is simply not valid. In fact, Schedule "A" to the Reply to the Notice of Appeal, the net worth computation, is a self-demolishing assumption.
[18] The appeals for all three years are allowed, and the Appellant is entitled to have the original assessments, which were based upon her returns for the three years, restored. Judgment will go referring the assessments back to the Minister for reconsideration and reassessment on the basis that the Appellant was correctly assessed for the years 1992, 1993 and 1994 by the Notices of Assessments which are dated October 27, 1994, September 1, 1994 and August 15, 1995.
[19] If I had the power to award costs beyond the out-of-pocket disbursements, if any, that the Appellant has sustained in this case I would most certainly do so. In my view, it is a travesty that the Appellant has been forced to go through this proceeding for the purpose of demolishing an assessment which the Deputy Attorney General of Canada should have been readily able to see was simply done by an invalid method. This case should never have had to come to Court. Unfortunately, I do not have any power to compensate the Appellant for that.
Signed at Ottawa, Canada, this 15th day of January, 2003.
|
"E.A. Bowie" |
J.T.C.C.
COURT FILE NO.: 2001-2406(IT)I
STYLE OF CAUSE: Marlene Francisco
and Her Majesty the Queen
PLACE OF HEARING: Toronto, Ontario
DATE OF HEARING: December 10, 11 and 13, 2002
REASONS FOR JUDGMENT BY: The Honourable Judge E.A. Bowie
DATE OF JUDGMENT: December 16, 2002
APPEARANCES:
Agent for the Appellant: Richard Kittar
Counsel for the Respondent: Lorraine Edinboro
COUNSEL OF RECORD:
For the Appellant:
Name: N/A
Firm: N/A
For the Respondent: Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada