Date: 20010522
Docket: 2000-3574-IT-I
BETWEEN:
ROBERT Z.S. URPESZ,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Bowman, A.C.J.
[1] These appeals are from assessments for 1994 and 1995. Both the appellant's representative, Mr. Follwell, and counsel for the Minister inform me that the assessments are for nil tax as a result of the application of losses from other years under section 111 of the Income Tax Act.
[2] The assessments were not put in evidence although they were attached to the notices of appeal and they do assess nil tax for each year, although the taxable income for 1994 is $13,226.
[3] The sole issue is therefore the imposition of penalties under subsection 163(2) of the Act. I asked counsel for the statutory basis upon which a penalty may be imposed where no tax is assessed, given that the penalty is a percentage of the additional tax assessed on the unreported income.
[4] Counsel referred me to paragraph 163(2.1)(c) which he says has the effect of preventing a reduction of the understatement of income by losses from other years under section 111. Whether the provision accomplishes what counsel says it is designed to accomplish is something that I need not consider since I have concluded that the respondent has not met the onus imposed upon her under subsection 163(3) of justifying the penalties.
[5] Counsel also conceded that the Minister has not on assessing after the objection reassessed for 1994 to reduce the penalties by $8,149 as stated in the T7W-C form accompanying the notice of assessment.
[6] The notices of assessment do not indicate the amount of the penalties or indeed that penalties were being assessed. Paragraph 9(j) of the reply states, inter alia, that penalties for 1994 and 1995 were assessed in the amounts of $1,655.25 and $258.30. Just how the Minister can state in the 1994 T7W-C form
Subsection 163(2) penalties are to be reduced by $8,149
when the reply says that all he assessed was $1,655.25 is something of a mystery. Is the Minister promising a credit of $8,149 - $1,655.25 or $6,493.75 that can be carried forward against future omissions?
[7] At the very least the reduction promised should completely eliminate the penalty imposed for 1994 leaving only a penalty of $258.30 for 1995 in issue. I suspect that what was meant was that the penalty would be reduced as a result of reducing the income by $8,149.
[8] The appellant carried on business in 1994 and 1995 as a used car dealer. Up to July 26, 1995 a business was carried on as North East Car Sales in Lindsay, Ontario. On November 20, 1995 another used car business was started by the appellant at a different location as Country Auto Sales.
[9] The audit originally resulted in an increase in sales by $45,889.17 for 1994, made up of sales invoices, auto sales deposits, vinyl sales and lease sales. For 1995 the auditor found unreported sales of $24,354.77.
[10] After further representations were made the unreported sales were reduced by the auditor for 1994 to $22,486.81 and for 1995 to $6,317.12. On objection the unreported sales for 1994 were reduced by $8,149 to $14,337.81.
[11] The auditor also disallowed a number of expenses but this disallowance did not form the basis of any penalty and was not challenged.
[12] The auditor, Ms. L. Borland, was called as a witness. I found her credible, conscientious and thorough and I can find no criticism of the manner in which she conducted the audit. She worked under extreme difficulty. The books of the appellant were not in good order and the appellant was not co-operative. Indeed if his conduct in court was any indication of his treatment of the auditor during the audit he was offensive.
[13] Ms. Borland compared the reported sales with other evidence of sales and leases and based her finding on the discrepancy between the sales reported and the total sales as determined by her.
[14] I cannot criticize this method of proceeding in raising an assessment of tax. An assessor can rely on such evidence, hearsay or otherwise, as is available and if the taxpayer disagrees he or she can appeal and must accept the onus of proving the assessment of tax wrong.
[15] In establishing the correctness of an assessment of penalties under subsection 163(2) different rules prevail. Under subsection 163(3) the respondent has the onus of proving all necessary constituent elements under subsection 163(2). This includes proving the amount of the understatement of income, the correctness of the amount of penalty and the fact that the understatement was made knowingly or in circumstances amounting to gross negligence.
[16] I asked counsel what evidence he relied upon in support of the penalty. His answer was that the appellant's records were inadequate. This is not evidence of gross negligence. He did not suggest that the alleged understatements of income were made knowingly. He had the appellant in the witness stand and could have cross-examined him on this point. His cross-examination should have been searching and thorough. It was perfunctory and desultory. It did not touch on the alleged understatements disclosed by Ms. Borland, nor on the circumstances in which they were made. Ms. Borland had laid the groundwork upon which the respondent might have built a case for imposing penalties but there was no follow-up.
[17] The rule was stated by Lord Hershell in Browne v. Dunn, (1893) 6 R 67, at 70-71:
Now, my Lords, I cannot help saying that it seems to me to be absolutely essential to the proper conduct of a cause, where it is intended to suggest that a witness is not speaking the truth on a particular point, to direct his attention to the fact by some questions put in cross-examination showing that that imputation is intended to be made, and not to take his evidence and pass it by as a matter altogether unchallenged, and then, when it is impossible for him to explain, as perhaps he might have been able to do if such questions had been put to him, the circumstances which it is suggested indicate that the story he tells ought not to be believed, to argue that he is a witness unworthy of credit. My Lords, I have always understood that if you intend to impeach a witness you are bound, whilst he is in the box, to give him an opportunity of making any explanation which is open to him; and, as it seems to me, that is not only a rule of professional practice in the conduct of a case, but is essential to fair play and fair dealing with witnesses. Sometimes reflections have been made upon excessive cross-examination of witnesses, and it has been complained of as undue; but it seems to me that a cross-examination of a witness which errs in the direction of excess may be far more fair to him than to leave him without cross-examination, and afterwards to suggest that he is not a witness of truth, I mean upon a point on which it is not otherwise perfectly clear that he has had full notice beforehand that there is an intention to impeach the credibility of the story which he is telling.
[18] It was essential to the Crown's case that the appellant be challenged on cross-examination on the alleged unreported sales and the reason for the alleged understatement. Failure to do so was fatal.
[19] The only authority counsel gave me was a 1979 decision of the Tax Review Board (Lahaie v. M.N.R., 79 DTC 743).
[20] As it happens, the authorities on this branch of the law are legion. One might start with the numerous pages under subsection 163(2) of the Act in the CCH Canadian Tax Reporter or the DeBoo Canada Tax Service. A recent case is Farm Business Consultants Inc. v. The Queen, 96 DTC 6085, in which the Federal Court of Appeal upheld a decision of this court (95 DTC 200). At pages 205-6 this court said:
I am cognizant of the fact that subparagraph 152(4)(a)(i) has as its purpose the opening up of returns for statute-barred years where items of income, for a wide variety of reasons, are omitted or misstated, whereas subsection 163(2) is a penal provision and that in applying it if there is doubt as to the type of conduct to which the misrepresentation is attributable the benefit of that doubt should be given to the taxpayer. In Udell v. M.N.R., 70 DTC 6019 Cattanach, J. said at page 6025:
There is no doubt that section 56(2) is a penal section. In construing a penal section there is the unimpeachable authority of Lord Esher in Tuck & Sons v. Priester, (1887) 19 Q.B.D. 629, to the effect that if the words of a penal section are capable of an interpretation that would, and one that would not, inflict the penalty, the latter must prevail. He said at page 638:
We must be very careful in construing that section because it imposes a penalty. If there is a reasonable interpretation which will avoid the penalty in any particular case, we must adopt that construction.
and at page 6026:
I take it to be a clear rule of construction that in the imposition of a tax or a duty, and still more of a penalty if there be any fair and reasonable doubt the statute is to be construed so as to give the party sought to be charged the benefit of the doubt.
See also Holley v. M.N.R., 89 DTC 366 at 369; De Graaf v. The Queen, 85 DTC 5280.
A court must be extremely cautious in sanctioning the imposition of penalties under subsection 163(2). Conduct that warrants reopening a statute-barred year does not automatically justify a penalty and the routine imposition of penalties by the Minister is to be discouraged. Conduct of the type contemplated in paragraph 152(4)(a)(i) may in some circumstances also be used as the basis of a penalty under subsection 163(2), which involves the penalizing of conduct that requires a higher degree of reprehensibility. In such a case a court must, even in applying a civil standard of proof, scrutinize the evidence with great care and look for a higher degree of probability than would be expected where allegations of a less serious nature are sought to be established.3 Moreover, where a penalty is imposed under subsection 163(2) although a civil standard of proof is required, if a taxpayer's conduct is consistent with two viable and reasonable hypotheses, one justifying the penalty and one not, the benefit of the doubt must be given to the taxpayer and the penalty must be deleted.4 I think that in this case the required degree of probability has been established by the respondent, and that no hypothesis that is inconsistent with that advanced by the respondent is sustainable on the basis of the evidence adduced.
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3 Cf. Continental Insurance Co. v. Dalton Cartage Co., [1982] 1 S.C.R. 164; 131 D.L.R. (3d) 599; 25 C.P.C. 72, per Laskin, C.J.C. at 168-171; D.L.R. 562-564; C.P.C. 75-77; Bater v. Bater, [1950] 2 All E.R. 458 at 459; Pallan et al. v. M.N.R., 90 DTC 1102 at 1106; W. Tatarchuk Estate v. M.N.R., [1993] 1 C.T.C. 2440 at 2443.
4 This is not simply an extrapolation from the rule in Hodge's Case (1838) 2 Lewin 227; 168 E.R. 1136, applicable in criminal matters such, for example, as section 239 of the Income Tax Act where proof beyond reasonable doubt is required. It is merely an application of the principle that a penalty may be imposed only where the evidence clearly warrants it. If the evidence is consistent with both the state of mind justifying a penalty under subsection 163(2) and the absence thereof — I hesitate to use the words innocence or guilt in these circumstances — it would mean that the Crown's onus had not been satisfied.
[21] I have obtained great assistance in this matter from two decisions of Strayer J. in Venne v. The Queen, 84 DTC 6247 and De Graaf v. The Queen, 85 DTC 5280. None of the cases I have mentioned were referred to by counsel.
[22] At page 6256 in the Venne decision Strayer J. said:
With respect to the possibility of gross negligence, I have with some difficulty come to the conclusion that this has not been established either. "Gross negligence" must be taken to involve greater neglect than simply a failure to use reasonable care. It must involve a high degree of negligence tantamount to intentional acting, an indifference as to whether the law is complied with or not. I do not find that high degree of negligence in connection with the misstatements of business income. To be sure, the plaintiff did not exercise the care of a reasonable man and, as I have noted earlier, should have at least reviewed his tax returns before signing them. A reasonable man in doing so, having regard to other information available to him, would have been led to believe that something was amiss and would have pursued the matter further with his bookkeeper.
[23] What emerges from these and other authorities is that in proving the appropriateness of a penalty under subsection 163(2) it is wholly inadequate for Crown counsel to attempt to prove on the basis of hearsay evidence some understatement of income, refrain from cross-examining the person to whom it is sought to attribute gross negligence and adduce no evidence of gross negligence.
[24] The Crown has simply not made out a case for penalties.
[25] The appeals are allowed and the penalties imposed under subsection 163(2) for the 1994 and 1995 taxation years are deleted. The appellant is entitled to his costs, if any, in accordance with the tariff.
Signed at Ottawa, Canada, this 22nd day of May 2001.
"D.G.H. Bowman"
A.C.J.