Date: 20010131
Docket: 2000-3276-IT-I
BETWEEN:
LEO DUCHESNE,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Bowman, A.C.J.
[1] These appeals are from assessments made under the Income Tax Act for the 1995, 1996 and 1997 taxation years. A related appeal under the Excise Tax Act was allowed on consent.
[2] The income tax assessments were made on the basis of the net worth method. I had occasion to consider the net worth method of determining income in Bigayan v. The Queen, [2000] 1 C.T.C. 2229, 2000 DTC 1619. It may be useful to repeat what was said there.
[2] The net worth method, as observed in Ramey v. The Queen, 93 DTC 791, is a last resort to be used when all else fails. Frequently it is used when a taxpayer has failed to file income tax returns or has kept no records. It is a blunt instrument, accurate within a range of indeterminate magnitude. It is based on an assumption that if one subtracts a taxpayer's net worth at the beginning of a year from that at the end, adds the taxpayer's expenditures in the year, deletes non-taxable receipts and accretions to value of existing assets, the net result, less any amount declared by the taxpayer, must be attributable to unreported income earned in the year, unless the taxpayer can demonstrate otherwise. It is at best an unsatisfactory method, arbitrary and inaccurate but sometimes it is the only means of approximating the income of a taxpayer.
[3] The best method of challenging a net worth assessment is to put forth evidence of what the taxpayer's income actually is. A less satisfactory, but nonetheless acceptable method is described by Cameron, J. in Chernenkoff v. Minister of National Revenue, 49 DTC 680 at page 683:
In the absence of records, the alternative course open to the appellant was to prove that even on a proper and complete "net worth" basis the assessments were wrong.
[4] This method of challenging a net worth assessment is accepted, but even after the adjustments have been completed one is left with the uneasy feeling that the truth has not been fully uncovered. Tinkering with an inherently flawed and imperfect vehicle is not likely to perfect it. The appellant chose to use the second method.
[3] Mr. Duchesne in the years in question carried on business of auto repairs, tow truck services and the sale of auto parts and tires under the name Duchesne Tire and Auto Parts.
[4] His practice was to give his bookkeeper, Mr. R.C. Wood, all invoices showing his sales and purchases and Mr. Wood would prepare the profit and loss statement for the business.
[5] The appellant's 1995 T-1 and 1997 T-1 income tax returns were put in evidence by the respondent. Mr. Duchesne did not bring his copies to court and as a result the 1996 return was not in evidence. Evidently the respondent could not find it.
[6] The 1995 return shows that the business had gross sales of $328,075 and a cost of sales of $226,025 for a gross profit of $103,002.37. The operating expenses in 1995 were $109,796 for a loss of $6,793. In 1997 the business had gross sales of $508,120 and a loss of $22,672. I do not have similar figures for 1996 but the business showed a loss of $7,964.
[7] On November 23, 1998 the Minister reassessed the appellant for 1995, 1996 and 1997 and added for those years $25,017, $25,894 and $32,199 respectively, resulting in a revised income of $19,309, $17,930 and $9,594. On objection he reassessed on January 24, 2000 and varied these figures.
[8] The amounts added were $23,729, $18,416 and $35,936, with the result that the final income as assessed was $18,021, $10,453 and $13,332 for those years. Schedules to the reply to the notice of appeal set out in some detail the way in which these figures were developed.
[9] Ms. Schlaepfer, the auditor of CCRA, testified that the initial step in the net worth audit was a comparison of the appellant's balance sheet at the beginning and the end of the year. This showed a decrease each year of $1,265, $3,055 and $4,400 respectively. She then added what were assumed to be his personal expenditures in each year of $25,000, based on national averages determined by Statistics Canada. In Bigayan I expressed doubts about the reliability of using Statistics Canada's figures in net worth calculations and I continue to doubt their reliability. Nonetheless they are often all we have to go on. In this case however, the point is moot because at the objection level the CCRA used actual drawings to determine the personal living expenses of the appellant and his wife. Exhibit A-1 lists the appellant's drawings for 1995 and 1996. There were no similar figures put in for 1997.
[10] For 1995 the drawings were $21,341 and for 1996 they were $17,733. The use of the actual drawings is reflected in the reassessments made on January 24, 2000 in which the assumed personal expenditures were reduced to $21,000, $17,000 and $21,000 for the three years.
[11] Several points should be noted.
(a) Mr. Duchesne stated that his personal expenditures for living expenses did not exceed $15,000 per year. Although I accept that he and his wife had a very frugal lifestyle I do not think that a ballpark guesstimate of this sort can carry much weight.
(b) The drawings were not deducted in computing income.
(c) Mr. Duchesne stated that he often took his tow truck home and worked from his home and that therefore some of the costs of his home should be treated as a business expense. The evidence does not permit me to make any finding in this respect.
(d) Both business and personal expenses were made out of the business account. This exacerbates the difficulty of reconstructing the true income of the business, particularly given the fact that the books and records were in a somewhat chaotic state to begin with.
[12] As was said in Bigayan, piecemeal tinkering with a net worth assessment is inherently unsatisfactory. It is like doing a minor tune up to an automobile that is missing a timing belt, if I may use an analogy that will be familiar to Mr. Duchesne. Nonetheless, where flaws are obvious they should be corrected.
[13] There are two adjustments that I think should be made to the net worth assessment.
[14] Mr. Duchesne stated that all of the Visa accounts were for business expenses and that personal expenses were put on Mastercard. He struck me as a thoroughly honest man and I accept his testimony. Indeed he was not challenged or cross-examined on this point (see Browne v. Dunn, [1894] 6 R 67 at 70-71 (H.L.).[1] It would follow that these payments should not have been included in his personal expenditures for the purposes of determining his income on the net worth method.
[15] The total of the Visa payments for 1995 by my calculation is $6,152.76 and for 1996 $6,981.19. I do not have similar figures for 1997 but they are no doubt readily ascertainable. The Visa payments should be deleted from the appellant's personal expenditures for 1995, 1996 and 1997 for the purpose of calculating his income using the net worth method.
[16] One other minor adjustment should be made. In 1997 there was added $2,250 identified as loss on sale of a Buick. This was not explained but prima facie it is difficult to see how a loss on the sale of an automobile can constitute an addition to one's net worth and therefore to one's income. In the absence of any explanation, I would delete this amount.
[17] The appeals are allowed and the assessments are referred back to the Minister of National Revenue for reconsideration and reassessment with these reasons. There will be no order for costs.
Signed at Ottawa, Canada, this 31st day of January 2001.
"D.G.H. Bowman"
A.C.J.
[1] The rule in Browne v. Dunn is discussed at some length in The Law of Evidence in Canada (Second Edition), Sopinka, Lederman & Bryant at paragraph 16-146 to paragraph 16-148. This court is frequently asked to disbelieve the testimony of a witness even though the witness was not cross-examined. Counsel appearing in this court would do well to familiarize themselves with the rule.