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Docket: 2002-2638(IT)G |
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BETWEEN: |
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CHARTWELL MANAGEMENT INC., |
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Appellant, |
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and |
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HER MAJESTY THE QUEEN, |
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Respondent.
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Appeal heard on October 18 and 19, 2004 at Saskatoon, Saskatchewan
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Before: The Honourable Justice D.W. Beaubier |
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Appearances: |
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Counsel for the Appellant: |
Kurt Wintermute |
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Counsel for the Respondent: |
Lyle Bouvier |
JUDGMENT
The appeals from the reassessments made under the Income Tax Act for the 1995, 1996 and 1997 taxation years are allowed and the reassessments are referred back to the Minister of National Revenue for reconsideration and reassessment.
No costs are awarded to any party.
Signed at Ottawa, Canada, this 8th day of November 2004.
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"D.W. Beaubier" |
Beaubier, J.
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Docket: 2002-2639(IT)G |
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BETWEEN: |
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CENTUS INC., |
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Appellant, |
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and |
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HER MAJESTY THE QUEEN, |
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Respondent.
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Appeal heard on October 18 and 19, 2004 at Saskatoon, Saskatchewan
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Before: The Honourable Justice D.W. Beaubier |
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Appearances: |
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Counsel for the Appellant: |
Kurt Wintermute |
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Counsel for the Respondent: |
Lyle Bouvier |
JUDGMENT
The appeals from the reassessments made under the Income Tax Act for the 1996 and 1997 taxation years are allowed and the reassessments are referred back to the Minister of National Revenue for reconsideration and reassessment.
No costs are awarded to any party.
Signed at Ottawa, Canada, this 8th day of November 2004.
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"D.W. Beaubier" |
Beaubier, J.
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Citation: 2004TCC728 |
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Date: 20041108 |
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Docket: 2002-2638(IT)G |
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BETWEEN: |
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CHARTWELL MANAGEMENT INC., |
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Appellant, |
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and |
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HER MAJESTY THE QUEEN, |
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Respondent,
Docket: 2002-2639(IT)G AND BETWEEN: CENTUS INC., Appellant, and
HER MAJESTY THE QUEEN, Respondent.
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Appeals heard on October 18 and 19, 2004 at Saskatoon, Saskatchewan
REASONS FOR JUDGMENT
Beaubier, J.
[1] These appeals pursuant to the General Procedure were heard together on common evidence at Saskatoon, Saskatchewan on October 18 and 19, 2004.
[2] The Appellants called Joseph Donlevy, B.A., M.B.A., the operating officer and director of the Chartwell Management Inc. ("Chartwell") at all material times; Douglas Konkin, B.Eng., M.Sc., P.Eng., the officer and operator of Centus Inc. ("Centus") at all material times; and Thomas Zurowski, C.A., a partner of KPMG, LLP., which was the accounting firm of Hypercore Technology Inc., ("Hypercore"), and Chartwell at all material times. The Respondent called Bonnie Lindgren the Canada Revenue Agency officer in charge of the Appellants' reassessments.
[3] Paragraphs 6 to 23 of the Reply to Chartwell's Notice of Appeal outline the matters in issue in these appeals for the years 1995, 1996 and 1997. They read:
6. With respect to paragraph 10 of the Notice of Appeal, he admits that the Appellant provided management services and equipment rentals to Hypercore for consideration totaling $13,268.00 in the 1995 fiscal period (the "1995 fee") but he has no knowledge of whether or not the fee was paid in the 1995 fiscal period and therefore does not admit that the Appellant was not paid the above noted amount as at December 31, 1995.
7. With respect to paragraphs 11, 17 and 23 of the Notice of Appeal, he admits that KPMG Chartered Accountants ("KPMG") prepared the Appellant's financial statements and income tax returns for the 1995, 1996 and 1997 fiscal periods, however, for greater certainty, he states that the financial statements and income tax returns were prepared based on information provided by the Appellant. He has no knowledge of the remaining allegations of fact contained in the above noted paragraphs and puts the Appellant to the strict proof thereof.
8. With respect to paragraphs 12, 18 and 24 of the Notice of Appeal, he admits that KPMG prepared the Appellant's financial statements and income tax returns for the 1995, 1996 and 1997 fiscal periods and that the amounts that the Appellant invoiced Hypercore were not included in the Appellant's financial statements or income tax returns. However, for greater certainty, he states that the above noted amounts were also not recorded in the Appellant's books and records. He has no knowledge of the remaining allegations of fact contained in the above noted paragraphs and puts the Appellant to the strict proof thereof.
9. With respect to paragraph 16 of the Notice of Appeal, he admits that the Appellant provided management services and equipment rentals to Hypercore for consideration totaling $60,015.00 in the 1996 fiscal period (the "1996 fee") but he has no knowledge of whether or not the fee was paid in the 1996 fiscal period and therefore does not admit that the Appellant was not paid either the 1995 or the 1996 fee as at December 31, 1996.
10. With respect to paragraph 22 of the Notice of Appeal, he admits that the Appellant provided management services and equipment rentals to Hypercore for consideration totaling $54,624.00 in the 1997 fiscal period (the "1997 fee") but he has no knowledge of whether or not the fee was paid in the 1997 fiscal period and therefore does not admit that the Appellant was not paid the 1995 fee, the 1996 fee or the 1997 fee as at December 31, 1997.
11. With respect to paragraph 29 of the Notice of Appeal, he admits that Develcon Electronics Ltd. ("Develcon") offered to purchase all of the outstanding shares in Hypercore, however, he has no knowledge of the remaining allegations of fact contained therein and puts the Appellant to the strict proof thereof.
12. With respect to paragraph 32 of the Notice of Appeal, he admits that Develcon purchased all of the outstanding shares in Hypercore, however, he has no knowledge of the remaining allegations of fact contained therein and puts the Appellant to the strict proof thereof.
13. The Appellant reported the following amounts on its T2 income tax returns for the 1995, 1996 and 1997 taxation years:
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1995 |
1996 |
1997 |
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Taxable Income |
$46,635.00 |
$28,921.00 |
$167,840.00
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Federal Income Taxes - Part I |
$5,705.49 |
$3,795.00 |
$29,675.00 |
14. The Minister of National Revenue (the "Minister") initially assessed the Appellant for the 1995 taxation year on September 30, 1996.
15. The Minister initially assessed the Appellant for the 1996 taxation year on August 18, 1997.
16. The Minister initially assessed the Appellant for the 1997 taxation year on September 28, 1998.
17. In computing its income for the 1995 taxation year the Appellant failed to include income earned totaling $13,268.00. In reassessing the Appellant for the 1995 taxation year the Minister added $13,268.00 to the Appellant's income. The Minister also assessed penalties in the 1995 taxation year pursuant to subsection 163(2) of the Act.
18. In computing its income for the 1996 taxation year the Appellant failed to include income earned totaling $60,015.00. In reassessing the Appellant for the 1996 taxation year the Minister added $60,015.00 to the Appellant's income. The Minister also assessed penalties in the 1996 taxation year pursuant to subsection 163(2) of the Act.
19. In computing income for the 1997 taxation year the Appellant failed to include income earned totaling $54,624.00. In reassessing the Appellant for the 1997 taxation year the Minister added $54,624.00 to the Appellant's income. The Minister also assessed penalties in the 1997 taxation year pursuant to subsection 163(2) of the Act.
20. The Minister issued Notices of Reassessment for the Appellant's 1995, 1996 and 1997 taxation years on July 27, 2000.
21. In so reassessing the Appellant for the 1995, 1996 and 1997 taxation years, the Minister relied on, inter alia, the following assumptions:
a) The Appellant is a corporation incorporated under The Business Corporations Act of Alberta that is extra-provincially registered under the Business Corporations Act of Saskatchewan;
b) At all relevant times, the Appellant carried on business in the Province of Saskatchewan which consisted of consulting, management services and equipment rentals;
c) At all relevant times, Martin Joseph Donlevy owned 50% and Claire Donlevy owned 50% of the issued and outstanding Class "A" shares in the capital of the Appellant;
d) At all relevant times, Martin Joseph Donlevy was also known as Joe or Joseph Donlevy.
e) At all relevant times, Joseph Donlevy was a director and held the office of secretary-treasurer of the Appellant;
f) At all relevant times, Joseph Donlevy was a shareholder of Hypercore;
g) At all relevant times, Joseph Donlevy was a director and held the office of president of Hypercore;
h) Joseph Donlevy managed Hypercore for the three years at issue and until the shares were sold to Develcon Electronics Ltd. ("Develcon") and he was responsible for the financial management of Hypercore, which included finding additional capital, applying for grants from CANARIE and applying for Scientific Research and Experimental Development ("SRED") claims;
i) At all relevant times, Hypercore carried on business in the Province of Saskatchewan consisting of scientific research and development;
j) During the 1995, 1996 and 1997 taxation years, the Appellant provided management services and computer equipment rentals to Hypercore;
k) During the 1995 taxation year the Appellant earned at least $13,268.00 from Hypercore by providing Hypercore with management services and computer equipment;
l) During the 1996 taxation year the Appellant earned $60,015.00 from Hypercore by providing Hypercore with management services and computer equipment;
m) During the 1997 taxation year the Appellant earned $54.624.00 from Hypercore by providing Hypercore with management services and computer equipment;
n) Joseph Donlevy prepared, or had a member of his staff prepare, invoices from the Appellant to Hypercore for the amounts specified in assumptions (k), (l) and (m);
o) The invoices referred to in subparagraph (n) were based on the amount of time Joseph spent managing Hypercore's business affairs and the amount of equipment rented;
p) The invoices referred to in subparagraph (n) were used by Hypercore to support its claims for SRED and CANARIE grants;
q) The amounts Hypercore received from SRED and CANARIE grants were reinvested in Hypercore, instead of being paid to the Appellant;
r) The Appellant agreed that the amounts Hypercore received from SRED and CANARIE grants should be reinvested in Hypercore;
s) The in-house staff, managed by Joseph Donlevy, prepared the Appellant's books and records;
t) The Appellant failed to record the above noted income or the receivables from Hypercore in its corporate books and records for 1995, 1996 and 1997; nor did the Appellant include the amounts in an allowance for doubtful accounts or bad debts in its books and records;
u) The Appellant failed to include the above noted amounts in income in filing its returns for the 1995, 1996 and 1997 taxation years;
v) All of the Appellant's revenue is generated by managing other business operations.
w) The Appellant's accountant also prepared Hypercore's income tax returns;
x) The Appellant's accountant stated that the amounts payable by Hypercore, which included the amounts paid to the Appellant, were converted to capital in order to support Hypercore's SRED claim;
y) The Appellant's accountant admitted that the conversion of payables to share capital is in fact payment of the expenditures and a subsequent reinvestment in Hypercore;
z) Joseph Donlevy has at least a basic understanding of tax matters;
aa) Joseph Donlevy has vast business experience with various corporations, government departments and personal financial activities;
bb) Joseph Donlevy signed a memo dated January 26, 1996, indicating that the Appellant agreed to loan the amount payable with respect to the equipment rentals to Hypercore;
cc) Joseph Donlevy signed an agreement on behalf of the Appellant converting the amount payable by Hypercore to the Appellant into contributed capital;
dd) The amounts payable to the Appellant by Hypercore were not bad debts;
ee) The Appellant did not attempt to collect the amounts from Hypercore;
ff) Hypercore continued to carry on its research;
gg) The potential of Hypercore's research continued to progress;
hh) Hypercore remained a going concern, funds continued to be injected into the company;
ii) Hypercore's financial statements did not account for the value of the technical knowledge gained by the company;
jj) Joseph Donlevy, the principal of the Appellant, was well aware of Hypercore's circumstances and potential;
kk) The Appellant continued to provide Hypercore with Mr. Donlevy's services and with computer equipment;
ll) Develcon was a public company;
mm) In 1995 Develcon bought shares in Hypercore and acquired an option to purchase additional shares;
nn) Develcon exercised the option;
oo) Develcon paid $1,483,937.40 for the shares;
pp) The Appellant's accountant, Tom Zurowski, concurred with the amounts being included in income;
qq) The Appellant's method of accounting for the amounts receivable from Hypercore did not adhere to the CICA Accounting Recommendations and generally accepted reporting methods; and
rr) The amount of $200,195.00 owing to the Appellant was shown as a shareholder loan in the Unanimous Shareholders Agreement.
ss) The Appellant reported taxable income of $43,635.00 in the 1995 taxation year. The Appellant's taxable income for the 1995 taxation year was at least $56,903.00. The income of the Appellant was understated by $13,268.00 in the 1995 taxation year;
tt) The Appellant reported taxable income of $28,921.00 in the 1996 taxation year. The Appellant's income for the 1996 taxation year was at least $88,936.00. The income of the Appellant was understated by $60,015.00 in the 1996 taxation year.
uu) The Appellant reported taxable income of $167,840.00 in the 1997 taxation year. The Appellant's taxable income for the 1997 taxation year was at least $222,464.00. The income of the Appellant was understated by $54,624.00 in the 1997 taxation year;
vv) By failing to include the above noted amounts in income the Appellant made misrepresentations in filing its returns for the above noted taxation years that is attributable to neglect, carelessness or wilful default;
ww) The Appellant knowingly, or under circumstances amounting to gross negligence in carrying out a duty or obligation imposed under the Act, made or participated in, assented to or acquiesced in the making of false statements or omissions in the income tax returns filed for the 1995, 1996 and 1997 taxation years, as a result of which the tax that would have been payable assessed on the information provided in the Appellant's income tax returns filed for those years was less than the tax payable by the amounts of $1,734.86, $17,463.16 and $15,906.51, respectively;
22. As a consequence of the said understatement of income, the Minister assessed the Appellant the following penalties under subsection 163(2) of the Act for the 1995, 1996 and 1997 taxation years:
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Taxation Year
|
Penalties |
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1995
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$867.43 |
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1996
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$8,731.58 |
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1997 |
$7,953.25 |
B. ISSUES TO BE DECIDED
23. The issues are:
(a) Whether the Appellant's income for the 1995, 1996 and 1997 taxation years was understated;
(b) Whether the Minister may make a reassessment for tax, penalties and interest in respect of the Appellant's 1995 taxation year pursuant to subparagraph 152(4)(a)(i); and
(c) Whether the Minister properly assessed penalties pursuant to subsection 163(2) of the Act in the 1995, 1996 and 1997 taxation years.
[4] Assumptions 21 a), b), c), d), e), f), g), i), j), k), l), m), n), o), p), s), t) and u), except for two invoices in 1995, w), z), ee), ii), but see paragraph [8] jj) below, jj), kk), ll), mm), nn), oo) and pp) were not refuted.
[5] With respect to the remaining assumptions in paragraph 21:
h) Is true except that Mr. Donlevy did not apply for the SRED grants. Those grants were applied for after Mr. Donlevy and Mr. Konkin had sold all of their shares to Develcon which then owned 100 percent of the shares in Hypercore.
q) The SRED grants were obtained after ownership of Hypercore was transferred to Develcon; how they were used by Develcon or Hypercore at that time is not known, but Hypercore was no longer in business.
r) The Appellants were not shareholders of Hypercore and their agreement or disagreement in respect to the CANARIE grants was irrelevant, since they were Hypercore's property. The SRED grants were applied for and received by Hypercore after the years in question.
v) Is wrong. Chartwell also rented equipment for fees.
x) and y) Are correct but the Appellants' accountant advised and recorded this on behalf of Hypercore in its capacity as Hypercore's accountant. The statement was made on the basis of the accountant's knowledge of the facts.
aa) Joseph Donlevy's business experience is extensive, but not "vast", and at the time included having been involved in the operations of two businesses which failed. Thus, the quality of that experience is questionable.
bb) Is correct. But the evidence is that the amounts invoiced were never paid to the Appellants to be loaned back in cash or even used as a book entry. Hypercore's cash flow problems were so great that its revenue was used to pay engineers' wages and to purchase necessary equipment, and not to pay the Appellants.
cc) Is wrong. Messrs. Donlevy and Konkin each signed the agreement on his own behalf as a shareholder but not on behalf of the Appellants.
dd) The amounts payable to the Appellants were never declared or elected by the Appellant to be doubtful or bad debts. However, the evidence before the Court is that Hypercore was always so short of cash of its own that it was at all times insolvent. Without loans from shareholders, new shareholders' capital and delaying payments to non-employees it would have always been in receivership or bankrupt. For this reason the amounts payable to the Appellants by Hypercore were at all times, in fact, bad debts.
ff) and gg) Hypercore carried on its research except from October 31 to December 31, 1995 when Hypercore lacked funds and from about June, 1997 on after which it never had sufficient funds and its engineers were doing demonstrations to possible lenders or investors. During these demonstrations it became clear to Mr. Konkin (and the Court accepts it as true) that the projected switch being developed by Hypercore had been passed by, by the industry which had adopted another system of technology for switches. In fact, due to insufficient funds Hypercore had to make do at all times with inadequate tools and with using programmable technology (rather than manufacturing its own integrated circuits), as a result of which its only demonstrable switch operated at one-half the projected speed and with unsatisfactory wiring and computer connections in 1997. An outside review by "Technica" which was required by Develcon in 1997, established that the proposed switch needed two more years of work, a further investment of 7 million dollars (U.S.) and the services of an experienced product development team.
hh) The result is that from its beginning in 1995 on, Hypercore was a limping concern operating from day to day with a shortage of cash, inadequate equipment and with limited staff. It could not develop its hypertube switch idea for telecommunications using the latest technology. As a result, from the moment that Hypercore was unable to manufacture its own integrated circuits for the hypertube switch, it was doomed to fail in the fast moving, high-tech, electronics business. That conclusion is not merely hindsight. The evidence of Mr. Konkin is that Hypercore's engineering staff knew then that they lacked the funds to manufacture their own integrated circuit. As a result, the Technica Study and Hypercore's own 1997 demonstrations further confirmed that what it had developed with the equipment it had was too slow compared to the standard Hypercore itself had set for the task of the switch.
hh) Thus, the injection of $200,000 in new shareholder's funds on September 25, 1997, (Exhibit A-3) was merely a stop gap. The cash flow projection by Hypercore in November and December 1995 and ultimately adopted in the CANARIE contract of January 23, 1996 (Exhibit A-1, Tabs 11, 12 and 13) established a shortage of $443,498 for which there was no source of funds. Moreover it was based on not meeting obligations to pay and paying invoices which were absolutely necessary 90 days late. All of its subsequent funds, except the $200,000, came from CANARIE grants.
qq) Is wrong. Exhibit A-1, 27, paragraph 16, of the CICA Accounting Recommendations states:
...
.16 Recognition of revenue requires that the revenue is measurable and that ultimate collection is reasonably assured. When there is reasonable assurance of the ultimate collection, revenue is recognized even though cash receipts are deferred. When there is uncertainty as to ultimate collection, it may be appropriate to recognize revenue only as cash is received.
...
It was on the basis of this that KPMG, LLP, as Chartwell's accountant, advised the Appellant not to show the invoices in its financial records and not to report them for income tax purposes. Mr. Donlevy advised Mr. Konkin of Centus of this advice and Centus adopted the same course. For unremembered reasons, and perhaps inadvertence, Chartwell failed to carry this advice out correctly respecting its 1995 financial statement, when it did record as a receivable for revenue purposes two management fee invoices, but did not report rental invoices from Chartwell to Hypercore. Both Mr. Donlevy and Mr. Konkin testified that Hypercore could not pay the invoices to their and the Appellants' knowledge, that they did not report them because they had faith in the knowledge and quality of KPMG's advice and that they did not fail to report the items in order to avoid paying taxes. Indeed, as Mr. Zurowski pointed out, the amounts could have been recorded and then written off, but the CICA handbook advised the course adopted, whereupon he advised it.
rr) The amounts in question were not shown as shareholder loans in the unanimous shareholders' agreement. They were simply recorded there, and the Appellants never executed that document.
ss), tt), uu), vv) and ww)Will be dealt with in what follows.
[6] Paragraphs 17 to 21 inclusive of the Reply to the Notice of Appeal of Centus Inc. outline the facts in issue in that matter. They read:
17. In computing income for the 1996 taxation year, the Appellant failed to include income earned totaling $26,000.00. In reassessing the Appellant for the 1996 taxation year, the Minister added $26,000.00 to the Appellant's income. The Minister also assessed penalties in the 1996 taxation year pursuant to subsection 163(2) of the Act.
18. In computing its income for the 1997 taxation year, the Appellant failed to include income earned totaling $26,000.00. In reassessing the Appellant for the 1997 taxation year, the Minister added $26,000.00 to the Appellant's income. The Minister also assessed penalties in the 1997 taxation year pursuant to subsection 163(2) of the Act.
19. The Minister issued Notices of Reassessment for the Appellant's 1996 and 1997 taxation years on July 31, 2000.
20. In so reassessing the Appellant for the 1996 and 1997 taxation years, the Minister relied on, inter alia, the following assumptions of fact:
a) The Appellant is a corporation;
b) The Appellant carried on business in the Province of Saskatchewan;
c) The Appellant's head office was in the City of Saskatoon, Saskatchewan;
d) The Appellant was engaged in the business of computer system management and/or computer system consulting;
e) At all relevant times, Douglas Konkin owned 76% and Mary Donlevy-Konkin owned 24% of the issued and outstanding shares in the capital of the Appellant;
f) At all relevant times, Douglas Konkin was a director and held the office of president of the Appellant;
g) At all relevant times, Douglas Konkin was a shareholder of Hypercore;
h) At all relevant times, Douglas Konkin was a director and held the office of secretary of Hypercore;
i) At all relevant times, Douglas Konkin was a computer manager of Hypercore;
j) Hypercore carried on business in the Province of Saskatchewan consisting of scientific research and development;
k) At all relevant times, Martin Joseph Donlevy, also known as Joe or Joseph Donlevy was responsible for the financial management of Hypercore, which included finding additional capital, applying for grants from CANARIE and applying for Scientific Research and Experimental Development ("SRED") claims;
l) During the 1996 and 1997 taxation years, the Appellant provided computer system management and/or computer system consulting to Hypercore;
m) During the 1996 and 1997 taxation years, the Appellant provided equipment and other goods to Hypercore;
n) During the 1996 taxation year, the Appellant earned at least $26,000.00 from Hypercore by providing Hypercore with computer system management and/or computer system consulting;
o) During the 1997 taxation year, the Appellant earned at least $26,000.00 from Hypercore by providing Hypercore with computer system management and/or computer system consulting;
p) Invoices from the Appellant to Hypercore for the amounts specified in assumptions n) and o) were based on the amount of time Douglas Konkin spent providing computer system management and/or computer system consulting;
q) Douglas Konkin agreed that the Appellant would invoice Hypercore and then loan the funds back to Hypercore;
r) The Appellant was aware that Hypercore set up the amounts owed to the Appellant as an account payable in its books and records;
s) The invoices referred to in subparagraph p) were used by Hypercore to support its claims for CANARIE and SRED grants;
t) The amounts Hypercore received from CANARIE and SRED grants were reinvested in Hypercore instead of being paid to the Appellant;
u) The Appellant agreed that the amounts Hypercore received from CANARIE and SRED grants should be reinvested in Hypercore;
v) Douglas Konkin prepared the Appellant's books and records;
w) The Appellant failed to record the above noted income or the receivables from Hypercore in its corporate books and records for 1996 and 1997; nor did the Appellant include the amounts in an allowance for doubtful accounts or bad debts in its books and records;
x) The Appellant failed to include the above noted amounts in income in filing its returns for the 1996 and 1997 taxation years;
y) All of the Appellant's revenue is generated by managing other business operations;
z) KPMG Chartered Accountants prepared Hypercore's income tax returns;
aa) KPMG Chartered Accountants stated that the amounts payable by Hypercore, which included the amounts paid to the Appellant, were converted to capital in order to support Hypercore's SRED claim;
bb) Douglas Konkin has at least a basic understanding of tax matters;
cc) Douglas Konkin has business experience with various corporations, government departments and personal financial activities;
dd) Douglas Konkin signed an agreement on behalf of the Appellant converting the amount payable by Hypercore to the Appellant into contributed capital;
ee) The amounts payable to the Appellant by Hypercore were not bad debts;
ff) The Appellant did not attempt to collect the amounts from Hypercore;
gg) Hypercore continued to carry on its research;
hh) The potential of Hypercore's research continued to progress;
ii) Hypercore remained a going concern, and funds continued to be injected into the company;
jj) Hypercore's financial statements did not account for the value of the technical knowledge gained by the company;
kk) Douglas Konkin was well aware of Hypercore's circumstances and potential;
ll) The Appellant continued to provide Hypercore with Douglas Konkin's computer system management and/or computer system consulting;
mm) Develcon was a public company;
nn) In 1995, Develcon bought shares in Hypercore and acquired an option to purchase additional shares;
oo) In 1998, Develcon exercised the option;
pp) Develcon paid $1,438.937.40 for the shares;
qq) The Appellant's method of accounting for the amounts receivable from Hypercore did not adhere to the CICA Accounting Recommendations and generally accepted accounting principles;
rr) The amount of $59,120.00 owing to the Appellant was shown as a shareholder loan in the Unanimous Shareholders Resolution;
ss) The Appellant reported a net loss of $11,550.00 in the 1996 taxation year;
tt) The Appellant's taxable income for the 1996 taxation year was at least $14,450.00;
uu) The income of the Appellant was understated by $26,000.00 in the 1996 taxation year;
vv) The Appellant reported a net loss of $4,975.00 in the 1997 taxation year;
ww) The Appellant's taxable income for the 1997 taxation year was at least $21,025.00;
xx) The income of the Appellant was understated by $26,000.00 in the 1997 taxation year;
yy) By failing to include the above noted amounts in income, the Appellant made misrepresentations in filing its returns for the above noted taxation years that is attributable to neglect, carelessness or wilful default;
zz) The Appellant knowingly, or under circumstances amounting to gross negligence in carrying out a duty or obligation imposed under the Act, made or participated in, assented to or acquiesced in the making of false statements or omissions in the income tax returns filed for the 1996 and 1997 taxation years, as a result of which the tax that would have been payable assessed on the information provided in the Appellant's income tax returns filed for those years was less than the tax payable by the amounts of $3,411.00 and $3,411.00 respectively.
21. As a consequence of the said understatement of income, the Minister assessed the Appellant the following penalties under subsection 163(2) of the Act for the 1996 and 1997 taxation years:
|
Taxation Year
|
Penalties |
|
1996
|
$1,705.50 |
|
1997 |
$1,705.50 |
[7] Assumptions 20 a) to j) inclusive, l) to s) inclusive, v) to z) inclusive, cc), ff), kk) to pp) inclusive, and ss) and vv) were not refuted.
[8] With respect to the remaining assumptions, the Court finds:
k) See [5] h) above.
t) See [5] q) above.
u) See [5] r) above.
aa) See [5] x) and y) above.
bb) This is not true. Mr. Konkin relied on Mr. Donlevy's advice in tax matters;
dd) See [5] cc) above.
ee) See [5] dd) above.
gg), hh) and ii) See [5] ff), gg) and hh) above.
jj) Is correct insofar as it is expressed. However, based on the comments on assumptions gg), hh) and ii) above and on the comments referred to therein, the technical knowledge gained by Hypercore was out of date due to the technology it was forced to use by its financial circumstances.
qq) See [5] qq) above. The Appellant relied on Mr. Donlevy's advice, which was based on knowledge he obtained from KPMG.
rr) See [5] rr) above.
tt), uu), ww), xx), yy) and zz) Will be dealt with in what follows.
[9] These assessments came about because the Appellants invoiced Hypercore and except as stated respecting Chartwell's two 1995 management fee invoices, did not record them in any way in their books and records. But Hypercore recorded and then claimed the invoices when applying for SRED grants. They were denied because Hypercore never paid the invoices. The SRED auditor advised the income tax section of the problem which had been created and these assessments and appeals followed.
[10] In particular, CRA is of the view that the Appellants simply cancelled the Hypercore debts, Messrs. Donlevy and Konkin sold their shares in Hypercore and, in essence were paid in that manner. Therefore CRA's argument is that Hypercore was under the management of Messrs. Donlevy and Konkin and could have paid the invoices somehow - essentially by robbing creditor Peter to pay creditor Paul. However the only money Hypercore ever got was either from CANARIE grants or from shareholder loans or capital. In other words, Hypercore never had the money to pay anything but wages, withholdings and essential outside supplies. It had to buy the supplies on the cheap due to lack of funds and this contributed to its failure. It was a vicious downward spiral, which was only sustained by the hope of finding new investors which were never forth-coming. Even at the time this was apparent to an objective observer, which was why it failed to obtain any more money from CANARIE or anyone else except the two who invested $200,000 but who were oblivious to the January 1996 forecast of a need for over $400,000 in additional money based upon late payments and withholdings. That forecast was incredibly optimistic. But that forecast and these facts are why the Court finds that the Chartwell and Centus invoices constituted bad debts even at the times that they were issued during the years in question.
[11] After December 15, 1995, the shareholdings in Hypercore were:
Joe Donlevy 24
Douglas Konkin 21
Carl McCrosky 15
Develcon 40
Total 100
These were split 100 for 1 on September 11, 1997. With the investment of $100,000 each on September 25, 1997 by Chelsea Management Inc. and VHL Management Inc. (Bearer shares), the shareholdings in Hypercore became, as quoted from Exhibit A-3:
|
Joe Donlevy |
2,400 |
17% |
|
Douglas Konkin |
2,100 |
15% |
|
Carl McCrosky |
1,500 |
10% |
|
Develcon |
4,000 |
28% |
|
Chelsea Management Inc. |
2,209 |
15% |
|
Bearer |
2,209 |
15% |
(See exhibit A-3)
Thus, after December 15, 1995 Messrs. Donlevy and Konkin were always minority shareholders of Hypercore.
[12] Mr. Donlevy admitted that before the sale of all of Hypercore's shares to Develcon, Hypercore received an offer to purchase its technology. But the shareholders would not accept it; they wanted to sell their shares. Messrs. Donlevy and Konkin were minority shareholders, so they had no control over this decision, which is a common decision for any shareholders of a small corporation if a share sale can be arranged. The Develcon offer for all of the non-Develcon shares in Hypercore of $1,483,937.40 followed on the basis that Hypercore was clean of any debt. Therefore all debt, including Chartwell's and Centus' was forgiven and the shares were sold by all the shareholders to Develcon. Mr. Donlevy believes that Develcon later sold Hypercore's technology to P.M.C. Sierra Inc. ("Sierra") for $2,000,000. Mr. Konkin went to work for Sierra with engineers. Sierra terminated its Hypercore technology programme a year later when it also failed to make it marketable.
[13] Part of the Respondent's theory is that Messrs. Donlevy and Konkin chose to cancel the Appellant's debts and sell capital. However that theory fails once it is understood that by the time that the offers came in Messrs. Donlevy and Konkin were in a distinct minority in a failed enterprise, namely Hypercore. In those circumstances, you do what you have to do. That is what Chartwell, Centus, Donlevy and Konkin did. In particular, the Court finds that Chartwell's and Centus' debts from Hypercore were bad debts anyway - cancelling them merely formalized a fact.
[14] Paragraph 12(1)(b) of the Income Tax Act required that the invoices be reported as receivables for income tax purposes. It reads:
12. (1) There shall be included in computing the income of a taxpayer for a taxation year as income from a business or property such of the following amounts as are applicable
...
(b) any amount receivable by the taxpayer in respect of property sold or services rendered in the course of a business in the year, notwithstanding that the amount or any part thereof is not due until a subsequent year, unless the method adopted by the taxpayer for computing income from the business and accepted for the purpose of this Part does not require the taxpayer to include any amount receivable in computing the taxpayer's income for a taxation year unless it has been received in the year, and for the purposes of this paragraph, an amount shall be deemed to have become receivable in respect of services rendered in the course of a business on the day that is the earlier of
(i) the day on which the account in respect of the services was rendered, and
(ii) the day on which the account in respect of those services would have been rendered had there been no undue delay in rendering the account in respect of the services;
...
[15] The Appellants did not do this, based upon the KPMG, LLP advice which, in turn, was based on the CICA handbook as quoted. But for tax purposes the Income Tax Act overrides the CICA handbook. However, the Court finds that the actions of the Appellants in relying on the advice of a major reputable international chartered accounting firm such as KPMG, LLP and on the CICA handbook, does not constitute negligence within the meaning of subsection 163(2) of the Income Tax Act and therefore the appeals are allowed in respect to the penalty portions of the assessments.
[16] However, Chartwell's willful default in reporting receivables in 1995 in direction violation of paragraph 12(1)(b) of the Income Tax Act does entitle the Respondent to reassess its 1995 taxation year.
[17] The Respondent did not refer to paragraph 12(1)(b) in any part of the audit processes or in the pleadings in these appeals. It referred to Section 9 of the Income Tax Act on the alleged premise that Section 9 included paragraph 12(1)(b).
[18] In these circumstances, the appeals are allowed and these matters are referred to the Minister of National Revenue for reconsideration and reassessment on the basis that the amounts in question for each Appellant for the years in dispute constituted bad debts in those years.
[19] No costs are awarded to any party.
Signed at Ottawa, Canada, this 8th day of November 2004.
|
"D.W. Beaubier" |
Beaubier, J.
|
CITATION: |
2004TCC728 |
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COURT FILE NOS.: |
2002-2638(IT)G and 2002-2639(IT)G |
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STYLE OF CAUSE: |
Chartwell Management Inc. v. The Queen Centus Inc. v. The Queen |
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PLACE OF HEARING: |
Saskatoon, Saskatchewan |
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DATE OF HEARING: |
October 18 and 19, 2004 |
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REASONS FOR JUDGMENT BY: |
The Honourable Justice Beaubier |
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DATE OF JUDGMENT: |
November 8, 2004 |
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APPEARANCES: |
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Counsel for the Appellant: |
Kurt Wintermute |
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Counsel for the Respondent: |
Lyle Bouvier |
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COUNSEL OF RECORD: |
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For the Appellant: |
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Name: |
Kurt Wintermute |
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Firm: |
MacPherson Leslie & Tyerman |
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For the Respondent: |
Morris Rosenberg Deputy Attorney General of Canada Ottawa, Canada |