|
Docket:2003-3694(IT)I |
|
2003-3696(IT)I |
|
BETWEEN: |
|
HARALD KERN, |
|
and ELKE KERN, |
|
Appellants, |
|
and |
|
|
|
HER MAJESTY THE QUEEN, |
|
Respondent. |
____________________________________________________________________
Appeals heard with the appeals of Harald Kern (2003-3693(GST)I),
and Elke Kern (2003-3695(GST)I) on March 3, 2004 and November 22, 2004,
at Charlottetown, Prince Edward Island, by
|
The Honourable Justice Campbell J. Miller |
|
|
Appearances: |
|
|
|
|
|
Agent for the Appellants: |
Harald Kern |
|
Counsel for the Respondent: |
Caitlin Ward and James Murphy |
____________________________________________________________________
JUDGMENT
The appeals from assessments made under section 227.1 the Income Tax Act, notices of which are dated February 28, 2002, and bear numbers 27055 and 27056 are dismissed.
Signed at Ottawa, Canada, this 5th day of May, 2005.
|
"CampbellJ. Miller" |
Miller J.
|
Docket:2003-3693(GST)I |
|
2003-3695(GST)I |
|
BETWEEN: |
|
HARALD KERN, |
|
and ELKE KERN, |
|
Appellants, |
|
and |
|
|
|
HER MAJESTY THE QUEEN, |
|
Respondent. |
____________________________________________________________________
Appeals heard with the appeals of Harald Kern (2003-3694(IT)I)
and Elke Kern (2004-3696(IT)I) on March 3, 2004 and November 22, 2004,
at Charlottetown, Prince Edward Island, by
|
The Honourable Justice Campbell J. Miller |
|
|
Appearances: |
|
|
Agent for the Appellants: |
Harald Kern |
|
Counsel for the Respondent: |
Caitlin Ward and James Murphy |
____________________________________________________________________
JUDGMENT
The appeals from assessments made under section 323 the Excise Tax Act, notices of which are dated February 27, 2002 and bear numbers 76677 and 76678 are allowed, without costs, and the matter is referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that the Appellants are liable for: (i) 1997 unremitted net tax of $48,161.85, interest of $2,557.47 and penalties of $3,443.61; (ii) 1999 unremitted net tax of $10,500, interest of $1,233.65 and penalties of $1,474.82. There are no taxes, interest or penalties for the period April 1, 1998 to September 30, 1999, for which the Appellants are liable.
Signed at Ottawa, Canada, this 5th day of May, 2005.
|
"CampbellJ. Miller" |
Miller J.
|
Citation: 2005TCC314 |
|
Date: 20050505 |
|
Docket:2003-3693(GST)I, 2003-3694(IT)I |
|
2003-3695(GST)I, 2003-3696(IT)I, |
|
BETWEEN: |
|
HARALD KERN, |
|
and ELKE KERN |
|
Appellants, |
|
and |
|
|
|
HER MAJESTY THE QUEEN, |
|
Respondent. |
|
|
REASONS FOR JUDGMENT
Miller J.
[1] These informal procedure appeals by Harald and Elke Kern are from assessments by the Minister of National Revenue (the Minister) under section 227.1 of the Income Tax Act and section 323 of the Excise Tax Act, assessing Mr. and Mrs. Kern as directors of 457189 B.C. Ltd. (the Corporation). There are two issues common to both the income tax and the excise tax appeals: first, have the Kerns proven the defence of due diligence to escape liability as directors; second, if not, can the Kerns attack the correctness of the underlying assessment against the Corporation to reduce their liability? I am convinced that the Kerns did not act with due diligence and they are therefore liable pursuant to section 323 of the Excise Tax Act and section 227.1 of the Income Tax Act. The question is, liable for how much, as I find the Kerns can attack both underlying assessments. I conclude that for the period 1997 to 1999, the Minister incorrectly assessed the goods and services tax (GST) pursuant to the Excise Tax Act, but correctly assessed the Corporation for source deductions pursuant to the Income Tax Act.
Facts
[2] The Corporation acquired a 57-room ocean front hotel (the Hotel) in Cowichan Bay, British Columbia in 1997. Mr. and Mrs. Kern were directors of the Corporation at the time and remained so throughout the relevant period. Mr. Kern had some previous experience operating a hotel, having owned an inn in Campbell River. The Hotel had a restaurant on the fifth floor and a beer and wine store on the third floor.
[3] Mr. Kern acknowledged that the Hotel had financial problems from the outset, in what he described as a very competitive, tough industry. He cited the example of the hot water boiler requiring $25,000 of repairs just a couple of days after acquiring the Hotel. He admitted he was overwhelmed by the daily problems of running the place - problems that continued for three years. The Corporation never showed a profit while under the Kerns' control.
[4] In January 1998, Mr. Kern claims to have leased the restaurant to Cherry Point Food Services, operated by Kurt Brown and Mary Carlson. Mr. Kern produced a one-page photocopy of what appears to be the first page of a lease of the restaurant commencing January 18, 1998 for a term of five years. The Respondent has accepted this arrangement, as restaurant sales were not included in the Corporation's GST calculation for 1998 and 1999.
[5] Mr. Kern also claims to have leased the beer and wine store in April 1998 to a British Columbia numbered company, 546401 B.C. Ltd. (546), again producing a photocopy of a lease, dated April 14, 1998, signed by Mr. Kern on behalf of the Corporation and Ms. Bjarnetson, on behalf of the tenant, 546. Ms. Bjarnetson also worked the front desk of the Hotel for the Corporation. The Respondent, although agreeing a lease was signed, requests that I give little or no weight to such lease, because the Corporation continued, according to the Respondent, to report beer and wine sales in its financial statements. The Canada Revenue Agency (CRA) auditor also testified that from a review of the Corporation's banking records, monies for 546 were deposited in the same bank account as the Corporation's deposits.
[6] The Corporation's financial woes were such that in 1999 Mr. Kern was considering several different scenarios as to how to create a profitable operation, including the possibility of a time-share setup. He deemed this appropriate given there were already separate titles to the rooms in a condo-like arrangement. Mr. Kern testified that he had financial worksheets prepared to be included in a prospectus. No preliminary prospectus was tendered in evidence. These financial worksheets, he said, were inadvertently faxed to CRA. In fact, worksheets for 1997 and 1998, which appear in the form of annual income statements, and which the Respondent refers to as the Corporation's financial statements, were attached to the Corporation's 1997 and 1998 tax returns filed in January 2000. The worksheets, or financial statements, for 1999, were monthly income statements; it is unclear exactly how the 1999 statements came into the hands of CRA. All these statements include income from the beer and wine store, but the 1998 and 1999 statements do not include revenue from the restaurant. The 1998 statements show beer and wine revenues of $376,555, but an overall loss from the Hotel operation of $251,336. This figure was reported on the Corporation's 1998 tax return. While Mr. Kern admits signing that return, he maintains he did not prepare nor file it, but it was most likely filed by the Receiver, who was appointed in early 2000.
[7] A 1999 tax return was not produced, though, as indicated, a monthly statement for each of the first nine months of 1999 was tendered in evidence in a similar format to the 1997 and 1998 annual statements. The heading of these statements varied: the 1997 and 1998 statements were headed with the name of the Corporation, while the monthly statements for 1999 were under the Hotel's trade name. Further, the nine monthly statements for 1999 showed over $400,000 profit.
[8] Mr. Kern presented bank statements for the first quarter of 1997, all of 1998 and three quarters of 1999. The Respondent asked that I give such evidence little or no weight as they are not supported by accounting documents necessary to establish their relevance. Yet, for 1997 and 1998 it appears the bank documents support Mr. Kern's assertions as to the correct revenue figures, not including beer and wine sales. The figures provided by Mr. Kern for the last quarter of 1999 appear to relate to revenues of 546, the company operating the beer and wine store. These figures suggest revenues of approximately $33,000 a month for beer and wine sales, which is not far off the average of $38,000 a month for beer and wine sales shown on the 1999 monthly income statements for the first nine months of 1999.
[9] During 1999, Mr. Kern realized he needed an additional $400,000 to stay afloat. He could not raise the money, and in December the bank started foreclosure proceedings. In January 2000, a Receiver was appointed. In February, the Receiver shut down the Hotel but continued to run the restaurant and the beer and wine store.
[10] With respect to the day-to-day operations and management of the Hotel, it was clear Mr. Kern was more involved than his wife. He spent three or four days a week at the Hotel. He had a desk near the front office where books and records were kept, although there appeared to have been little in the way of books and records. There were no separate accounts for payroll or GST and no list of employees. Mr. Kern claims he calculated GST remittances, but someone else looked after T4s; likely the people working at the front desk. He mentioned that Ms. Bjarnetson was one of those who worked at the front desk. He claimed that four employees, whose source deductions were paid by the Corporation, were in fact employees of the beer and wine store, not of the Corporation. Mr. Kern did not seek assistance or professional accounting services in attending to his books.
[11] Mr. Randy Young, the CRA auditor, testified that he audited the Corporation commencing in May 2000 and continuing until March 2001. The only original books and records he was able to obtain were documents contained in four boxes from the Receiver pertaining to the 1997 taxation year. Included in these materials was the 1997 daily revenue summary. Mr. Young reviewed the last three months of 1997 and determined there was a $17,000 discrepancy between what was reported by the Corporation and what was actually collected as GST. He also reviewed a provincial sales tax audit conducted by the British Columbia authorities, who had in turn reviewed the Corporation's bank deposits. Mr. Young concluded that the Corporation had understated its GST liability by approximately $48,000 for the 1997 year.
[12] For determining the GST liability for 1998, Mr. Young again considered the provincial audit, as well as relying on the financial statements, mentioned earlier, filed by the Corporation with the 1997 and 1998 income tax returns. He concluded there was a GST shortfall of $1,137. Mr. Young also spoke to Ms. Bjarnetson who advised him the GST filings went through the numbered company (it was unclear from Mr. Young's testimony which numbered company Ms. Bjarnetson might have been referring to).
[13] Mr. Young likewise relied on the 1999 monthly financial statements for his 1999 findings, reaching the following conclusions of GST shortfalls: for the first quarter of 1999, $10,939; for the second quarter, $18,593; and for the third quarter, $20,144. Mr. Young's testimony of the GST liability for 1999 differed from that assessed, which was as follows: for the first quarter, $7,424; for the second quarter, $29,166; for the third quarter, $24,227 and for the fourth quarter, $12,500. The Respondent's written explanation was:
... The variance is the result of adjustments made by the CCRA in the period between January 5, 2001 and February 27, 2002. When input tax credits were reported in one taxation period, that credit was applied to GST owing in another period. The $12,500 assessed in the period ending December 31, 1999 in the Notice of Assessment was based on a notional assessment.
[14] With respect to payroll, CRA compared employees' T4s with the Corporation's T4 summary, concluding there were unremitted source deductions. Mr. Kern accepts the Respondent's position vis-à-vis source deductions for 1997, but objects to certain amounts in 1998 and 1999.
[15] With respect to the source deductions, a certificate of registration for the Corporation's liability was registered on January 8, 2001 in the Federal Court of Canada in the amount of $36,618.59. The Federal Court issued a writ of seizure and sale on June 8, 2001, which was returned unsatisfied in whole on January 31, 2002. The Respondent has since collected a significant amount towards this liability.
[16] At all relevant times, the Corporation was registered under Part IX of the Excise Tax Act. On June 6, 2001 a Certificate of Registration for the Corporation's liability under the Excise Tax Act was registered in the Federal Court of Canada in the amount of $191,797.16, coincidentally with the issuance of a writ of seizure and sale. On January 31, 2002, the execution was returned to the Minister unsatisfied in whole. The Corporation never filed an objection or appealed. On February 27, 2002, the Respondent assessed the Appellants for the net tax remittable by the Corporation of $122,617.35 plus penalties of $59,390.97 and interest of $25,785.50 for a total of $207,793.82, as more particularly set out in Schedule "A" attached to these Reasons which was attached to the Respondent's Replies to the Notices of Appeal.
Analysis
[17] This is a director's liability case brought pursuant to section 227.1 of the Income Tax Act and section 323 of the Excise Tax Act. Both these provisions provide for a due diligence defence. I will address that issue before dealing with the issue of the underlying assessments.
[18] Mr. Kern did not strenuously argue that he or his wife acted with such due diligence as to escape liability. For good reason. The facts do not support such a position. Mr. Kern was well aware of the financial difficulties the operation was facing from the very start of his involvement, yet he did nothing to establish systems or procedures to safeguard the interest of the Government in receiving source deductions and GST payments. Mr. Kern was not a novice in this industry. He would have been well aware of the requirements, yet he did not even engage an accountant to assist him. No separate account was set up. There was not even an employee list. Mr. Kern displayed a nonchalant attitude towards record-keeping to the point of suggesting it was really the front desk staff responsible for such matters. I find Mr. Kern did not exercise the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances. The test has well been established by case law and Mr. Kern has failed to meet that test.
[19] What about Mrs. Kern? She did not testify, but it was clear from Mr. Kern's testimony that she was not actively involved. Indeed, Mr. Kern suggested that Mrs. Kern did not care much for the place. She might have given more thought to accepting the position of director in such circumstances. She was a director. I agree with the comments of Justice Marceau in Soper v. The Queen[1] where he stated:
Subsection 227.1(1) makes a director liable for the failure of his or her corporation to remit the monies withheld as taxes and other source deductions from its employees' salaries, and subsection 227.1(3) relieves a director of his or her liability if he or she can show that he or she exercised a certain degree of care, diligence and skill to prevent such failure. By these provisions, Parliament, I think, has imposed on a director of a corporation a completely new, separate and positive duty. Such duty is owed not to the corporation but to the Crown, and consists of an obligation to do what one reasonably can to prevent such failure from occurring. I simply cannot imagine that such a duty may ever be seen as having been fulfilled by a director who, as here, has never put his or her mind to the requirement and has remained completely uninterested and passive with respect to it.
Mrs. Kern has not fulfilled her duty by remaining completely uninterested and passive. I find she too is liable.
Right to attack underlying assessments
[20] I turn now to the thorny issue of the Kerns' ability to question the underlying assessments of the Corporation. It is clear from a review of cases in this Court dealing with a director's right to attack an underlying corporate assessment in a section 323 Excise Tax Act case, that there are opposing points of view. For those who believe directors may not attack the corporate assessment, see for example Schuster v. The Queen,[2] Maillé v. The Queen[3] and the recent case of Zaborniak v. The Queen[4] (the "con-position"). For those who believe the directors may attack an underlying assessment, see Lau v. The Queen,[5] Weins v. The Queen,[6] and Parisien v. The Queen[7] (the "pro-position"). The latter cases follow the lead of the Federal Court of Appeal in Gaucher v. The Queen,[8] in which the Court invoked the principles of natural justice:
[6] I am of the respectful view that the Tax Court Judge was in error in coming to this conclusion. It is a basic rule of natural justice that, barring a statutory provision to the contrary, a person who is not a party to litigation cannot be bound by a judgment between other parties. The appellant was not a party to the reassessment proceedings between the Minister and her former husband. Those proceedings did not purport to impose any liability on her. While she may have been a witness in those proceedings, she was not a party, and hence could not in those proceedings raise defences to her former husband's assessment.
[7] When the Minister issues a derivative assessment under subsection 160(1), a special statutory provision is invoked entitling the Minister to seek payment from a second person for the tax assessed against the primary taxpayer. That second person must have a full right of defence to challenge the assessment made against her, including an attack on the primary assessment on which the second person's assessment is based.
[8] This view has been expressed by Judges of the Tax Court. See, for example, Actonv. The Queen (1994), 95 DTC 107, at 108 per Bowman, T.C.C.J.; Ramey v. The Queen (1993), 93 DTC 791, at 792 per Bowman, T.C.C.J.; Thorsteinson v. M.N.R. (1980), 80 DTC 1369, at 1372 per Taylor, T.C.C.J. While the contrary view was expressed in Schafer (A.) v. Canada, [1998] G.S.T.C. 7-1, at 7-9 (appeal dismissed for delay (August 30, 1999), A-258-98 (F.C.A.)), I am of the respectful opinion that such view is in error. It seems to me that this approach fails to appreciate that what is at issue are two separate assessments between the Minister and two different taxpayers. Once the assessment against the primary taxpayer is finalized, either because the primary taxpayer does not appeal the assessment, or the assessment is confirmed by the Tax Court (or a higher court if further appealed), that assessment is final and binding between the primary taxpayer and the Minister. An assessment issued under subsection 160(1) against a secondary taxpayer cannot affect the assessment between the Minister and the primary taxpayer.
I wade into the debate on the side of the pro-position, not just based on principles enunciated in Gaucher, but also on the basis of statutory interpretation. The sections in issue under the Excise Tax Act are subsections 228(1), 296(1) and 323(1), (2) and (3)
228(1) Every person who is required to file a return under this Division shall, in the return, calculate the net tax of the person for the reporting period for which the return is required to be filed, except where subsection (2.1) or (2.3) applies in respect of the reporting period.
...
296(1) The Minister may assess
(a) the net tax of a person under Division V for a reporting period of the person,
(b) any tax payable by a person under Division II, IV or IV.1,
(c) any penalty or interest payable by a person under this Part,
(d) any amount payable by a person under any of paragraphs 228(2.1)(b) and (2.3)(d) and section 230.1, and
(e) any amount which a person is liable to pay or remit under subsection 177(1.1) or Subdivision a or b.1 of Division VII,
and may reassess or make an additional assessment of tax, net tax, penalty, interest or an amount referred to in paragraph (d) or (e).
323(1) Where a corporation fails to remit an amount of net tax as required under subsection 228(2) or (2.3), the directors of the corporation at the time the corporation was required to remit the amount are jointly and severally liable, together with the corporation, to pay that amount and any interest thereon or penalties relating thereto.
323(2) A director of a corporation is not liable under subsection (1) unless
(a) a certificate for the amount of the corporation's liability referred to in that subsection has been registered in the Federal Court under section 316 and execution for that amount has been returned unsatisfied in whole or in part;
(b) the corporation has commenced liquidation or dissolution proceedings or has been dissolved and a claim for the amount of the corporation's liability referred to in subsection (1) has been proved within six months after the earlier of the date of commencement of the proceedings and the date of dissolution; or
(c) the corporation has made an assignment or a bankruptcy order has been made against it under the Bankruptcy and Insolvency Act and a claim for the amount of the corporation's liability referred to in subsection (1) has been proved within six months after the date of the assignment or bankruptcy order.
323(3) A director of a corporation is not liable for a failure under subsection (1) where the director exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances.
[21] The director's liability only arises after a company has demonstrated it cannot pay. Prior to that time the directors are not liable, and obviously there can be no assessment against them, against which a director can object. Certainly the company can object and appeal, but, practically, a company heading for insolvency is unlikely to do so. Advocates of the con-position suggest that directors have the right through the company to attack the corporate assessment and thus indirectly deal with what might become an assessment against them. But the directors and the company are distinct and separate legal entities. I can imagine scenarios where a director may be unaware of an appeal by the company of its assessment. Yet, must he or she subsequently be bound by that assessment? I believe this runs contrary to the basic rules of natural justice raised in Gaucher.[9]
[22] Is it sufficient to rely on rules of natural justice to counter the reasoning of Justice Bowie in Zaborniak[10] in interpreting the legislation? Is the language as unambiguous as Justice Bowie suggests? He wrote:
4 In enacting Part IX of the Act, Parliament made provision whereby the liability of a registrant to pay net tax, together with any interest or penalty, may be fixed by the Minister by means of an assessment made under subsection 298(1). Section 299 is carefully drafted to provide that the registrant's liability is precisely fixed by any such assessment. It is deemed to be valid and binding, subject only to either a subsequent reassessment by the Minister, or being vacated following the process of objection and appeal that is provided for in sections 301 to 307. The processes for objection and appeal are available only to the person who has been assessed. The amount of net tax, interest or penalty assessed, subject only to reassessment, or vacating of the assessment as a result of an objection or an appeal, is a debt due to Her Majesty in Right of Canada, and when so certified by the Minister under section 316 the certificate is deemed to be a judgment of the Federal Court.
5 ... The liability that this section imposes on the directors, jointly and severally with the corporation, is "... to pay that amount and any interest thereon or penalties relating thereto"; that amount, read in its context in subsection 323(1), and having regard to the scheme of subdivision e of the Act, can only mean the amount of net tax that the corporation has failed to remit as required. Section 323 only permits the Minister to assess a director where that amount is either an amount that is deemed to be a judgment debt for which execution against the debtor has been returned unsatisfied, or else a claim proved in liquidation or dissolution proceedings, or in bankruptcy. In the present case it is a (deemed) judgment debt.
...
7 To find that the Appellants in this case have a right to dispute the quantum of the judgment debt would require that I add to subsection 323(1), by implication, the words "or such lesser amount as the corporation might have been found liable to remit following a successful appeal of its assessment". I simply have no mandate to do that.
I prefer to approach the analysis starting, rather than concluding, with the director's liability in section 323. Subsection 323(1) renders a director liable for the amount of tax required to be remitted under section 228. The amount of net tax referred to in section 228 is an amount determined at that stage by the Corporation. The Minister's authority to assess is found in section 296: if the Minister disagrees with the Corporation's determination, then the amount of net tax assessed will obviously differ from the amount of the determination made by the Corporation pursuant to section 228. Who determines then what is the correct amount or "that amount" as referred to in subsection 323(1), for purposes of director's liability?
[23] The Corporation is liable for the amount determined by the Government, and such amount is a tax debt due by the Corporation. But because one of the conditions precedent in subsection 323(2) has been met, that does not validate the Government amount as "that amount" for purposes of subsection 323(1). The conditions set out in subsection 323(2) are conditions precedent only; effectively, timing provisions. They do not, by their very occurrence, justify the Government's amount as the correct amount for purposes of director's liability. If one of the conditions is met, a director is liable for an amount, an amount in this case which represents the Government's assessed amount - an amount not subjected to judicial scrutiny. Clearly a company, by not objecting on a timely basis, has foregone the right for that judicial review; and does indeed have a certificate deemed to be a judgment against it for a certain amount. But where does the Act say that a director has foregone such a right? It does not.
[24] In this case, the Government has assessed the directors based on its unchallenged determination of the amount required to be remitted under subsection 228(2). It is a fact that the Government assessed that amount; it is a fact that the Corporation did not object or appeal and is liable for that amount; it is not a fact, however, that the assessed amount under such circumstances is the correct amount to have been remitted under section 228 for purposes of director's liability pursuant to section 323. The amount for which the directors are ultimately liable is the amount of net tax required to be remitted under subsection 228(2), not the amount certified and deemed a judgment against the Corporation where there has been no challenge of that amount. Unless the assessed amount has been judicially tested, the Government cannot fairly impose its unchallenged assessment against third parties, the directors, on the basis that "that amount" in section 323 reflects the correct amount of the unremitted net tax. I do not believe one needs to imply any words into section 323 to qualify "that amount" to mean something lesser than assessed by the Government. The object of the exercise, vis-à-vis the directors, is that they be liable for the correct amount of unremitted tax; and if the company does not take the steps to have that correct amount judicially determined, then "that amount" remains open to be challenged by the directors by an appeal to this Court.
[25] I recognize that this result, while different from the result in Zaborniak,[11] does perhaps not go as far as what might be drawn from Gaucher.[12] It must be left to the Federal Court of Appeal to clarify how Gaucher is to apply to director's liability pursuant to the Excise Tax Act. The foregoing approach would not benefit the director, who, for whatever reasons, is out of the loop and is unaware his company has appealed and lost an assessment of its net tax owing under the Excise Tax Act. Under those circumstances, I believe the fact of the amount of net tax owed by the company has been established; that is, "that amount" for purposes of section 323 has indeed been determined, and the unaware director is out of luck. The Gaucher case may throw a lifeline to such a director; I do not have to make that determination in this case.
[26] Relying solely on Gaucher may provide broader opportunities for a director to attack an underlying assessment. Relying on a statutory interpretation of section 323, while considering principles of natural justice leads to a somewhat narrower result. To be clear, if the Corporation had appealed the assessment and lost, the directors may well be precluded from attacking the assessment on a section 323 appeal, even if the director may have had no involvement in, or even knowledge of the Corporation's appeal. In such a case, resort may only be to principles of natural justice.
[27] Based on the reasoning in Gaucher,[13] and similar statutory interpretation as outlined above, I would also allow the Kerns to attack the underlying assessment under the provisions of the Income Tax Act.
GST underlying assessment
[28] Having determined I can review the underlying assessment, I turn first to the underlying GST assessment. I believe there are two questions to be determined in assessing the correctness of the Minister's GST assessment: first, whether the Corporation's sales involve sales from the beer and wine store; second, whether the annual financial statements of 1997 and 1998 and the monthly income statements for the first nine months of 1999 are to be accepted as accurate for purposes of determining the GST liability.
[29] The Respondent relies heavily on the fact that the 1998 financial statements filed with the Corporation's 1998 return in early 2000 contained the beer and wine sales figures. From this, the Respondent wants me to conclude that the Corporation must include such sales in calculating its GST liability. Contrary to that conclusion is the fact that there was a lease between the Corporation and 546. Also, there is evidence of bank deposits confirming that in the last quarter of 1999, 546 recorded deposits of an average of $33,000 a month. This compares reasonably to the monthly revenues from the first nine months of 1999, which averaged approximately $38,000.
[30] I also note Mr. Kern's comment that "once you have a significant loss, the numbers for tax purposes are somewhat academic". It was clear he cared little about the accuracy of the income tax returns as no tax was exigible. So, if those financial statements showed beer and wine revenues that rightfully were revenues of another company, but still led to no tax owing, Mr. Kern simply would not have been concerned. This would especially be so if that other company was related. Mr. Kern presented bank materials for 546: he included revenues of that company in the overall operation. This is consistent with a finding that Mr. Kern had some involvement with both the Corporation and 546, notwithstanding that Ms. Bjarnetson signed the lease on behalf of 546. This seems a more plausible explanation as to why the two companies' numbers were together on financial statements prepared by Mr. Kern, than his story that the numbers, certainly for 1997 and 1998, were for prospectus purposes. I conclude beer and wine revenues were not revenues of the Corporation, but of 546.
[31] The monthly 1999 income statements were not tendered in evidence as having been attached to a 1999 return. The 1999 statements were no longer titled with the Corporation's name (as in 1997 and 1998) but were headed "Howard Johnson at the Water Income Statements". They were prepared at a time (1999) when financial matters were a serious problem for Mr. Kern. He needed to find an additional $400,000. Yet the monthly figures shown on the monthly income statements give revenues from the Hotel (not including beer and wine sales) in July alone of $233,000. This is two-thirds of all the revenues from the Hotel in all of 1998. Those statements go on to show considerable profit. I find that these monthly financial statements for 1999, unlike the yearly statements for 1997 and 1998 which were filed with income tax returns, are projections only. They do not accurately reflect realistic Hotel revenues for the period. To extrapolate Hotel revenues over the full 1999 year based on those figures would yield revenues of approximately $1,150,000. Compared to the 1998 figures taken from the financial statements that the Respondent wants us to accept, this represents an increase from approximately $324,000 of revenue (not including beer and wine sales) for 1998 to $1,150,000 for revenue (not including beer and wine sales) in 1999. This simply does not make any sense for an operation that was heading into insolvency. Yet this is what the Respondent relies upon. I appreciate the Respondent was thwarted by lack of originating accurate ledgers, books and records from the Appellants. I also appreciate the Respondent relied to some extent on the work of a provincial auditor, from whom I received no direct evidence. Yet, an element of commercial common sense suggests the numbers relied upon in 1999 by CRA are wildly out of whack with reality.
[32] What then to conclude about a possible correct assessment? I will deal in rough numbers, as it is clear from both sides, accuracy is unattainable. First, I remove from the GST calculation from April 1998 to December 31, 1999 the beer and wine sales. For 1998, this would more than offset the amount owing of $1,137.11. For 1999, this would result in a reduction of approximately $24,000 for the first three-quarters of 1999, (that is, 7% on beer and wine sales from statements of approximately $343,000). With respect to the GST on the Hotel for the first three-quarters of 1999, the Respondent assessed based on additional sales over the reported sales of the Corporation, of $526,000 from the Hotel alone (this is the $869,000 projected less the $343,000 from beer and wine sales). This results in GST of 7% on $526,000 or $36,820. Based on bank deposit information provided by Mr. Kern, the Hotel operations in the first three-quarters of 1999 yielded approximately $450,000, which is approximately what the Corporation reported. Those figures are more in line with the two prior years' revenues, but still represent some increase in revenues in 1999. I find the additional extra half-million revenue set forth in the 1999 income statement was a fiction, and should not have been relied upon by the Respondent.
[33] With respect to the last quarter of 1999, the only evidence from Mr. Kern appears to relate to beer and wine sales of 546. Further, Mr. Young, the CRA auditor, gave no evidence as to how the $12,500 tax liability was derived, though the Respondent's counsel suggested it was a "notional assessment". If revenue figures for the last quarter of 1999 are extrapolated from the first three-quarters of 1999, the revenue upon which GST should have been reported would be $150,000, resulting in a tax liability of $10,500.
[34] With respect to the 1997 GST liability, Mr. Kern acknowledged the Corporation was running all aspects of the operation in that year (Hotel, restaurant, beer and wine). Mr. Young's review resulted in a GST liability based on sales of approximately $940,000. This is very close to the total sales reflected in the 1997 income statement of the Corporation. As I have previously stated, I find the 1997 and 1998 annual income statements titled "457189 B.C. Ltd. Income Statement" are not simply working papers for prospectus purposes, as Mr. Kern suggests. The 1999 monthly statements are another matter.
[35] Mr. Young testified that for 1997, he did review three months worth of daily revenue documents he gleaned from boxes obtained from the Receiver. From this, he concluded there was a shortfall for the last quarter of 1997, and upon comparing this to the results of the provincial audit conducted by his British Columbia counterparts, he extrapolated a shortfall for the 1997 year of $48,000 GST liability. What is somewhat curious is that this reflects a significantly higher revenue than indicated on the 1997 income statement, attached to the Corporation's 1997 income tax return.
[36] While I have some doubts about the accuracy of the numbers contained in the 1998 statement and serious concerns about the numbers in the 1999 monthly statements, I have no other information for 1997 other than the 1997 statements, to provide a breakdown among Hotel revenues of 30%, restaurant revenues of 30% and beer and wine store revenues of 40%. Based on those breakdowns, to accept the Respondent's additional $48,000 tax liability would mean accepting additional Hotel revenues of 30% of $685,000, or $205,000. The 1997 income statement suggests Hotel revenues of approximately $290,000, so on this basis the Minister is indirectly suggesting a more accurate figure of $495,000 annually for Hotel revenues. I find this is more in accordance with what I have found to be the 1999 Hotel revenues of $600,000. All to say that given this result, and given this assessment of 1997 was based on original Corporation's records, I accept the Respondent's assessment of tax for 1997 of $48,161.85.
[37] In summary on the GST assessments, if this result appears to the parties as a rough and ready solution, they are absolutely right, but they have left me no other option. In a suit with in excess of $200,000 at stake for the Appellants, neither side chose to take the general procedure, where exchange of documents and examinations for discovery would have afforded both sides a much greater opportunity to establish what truly happened. Instead, they chose to role the dice by putting limited information before me, much of which I have found inaccurate. This is an informal procedure case; it is not an audit, and I am not an auditor. I have decided based on what makes the most commercial sense from the sketchy evidence provided, with no apologies for what might be perceived as rough edges. The numbers I have arrived at are founded on the following conclusions:
(i) In 1997, the Corporation operated all three aspects of the business: Hotel, restaurant and beer and wine store;
(ii) After April 15, 1998, the Corporation only operated the Hotel;
(iii) The CRA auditor had books and records for October, November and December 1997 from which he drew reasonable conclusions, confirmed by the results of a provincial audit;
(iv) In 1998, the removal of the revenues from the beer and wine store offset any additional GST liability the Respondent assessed; and
(v) In 1999, it was inappropriate to rely on the monthly income statements; the bank deposit information is more persuasive in concluding that Hotel revenues were approximately $600,000 for the year.
[38] Based on these conclusions, the correct assessments for which the Kerns are liable as directors are as follows:
(a) For 1997, the Respondent's position is accepted that the Corporation is liable for $48,161.85 of tax plus interest and penalties as assessed.
(b) For 1998, no tax, penalties or interest; and
(c) For 1999, the Corporation is liable for $10,500 tax in the last quarter only, plus interest and penalties of $1,233.65 and $1,474.82, respectively.
Income Tax
[39] Mr. Kern agreed with the assessment against the Corporation for the failure to remit in 1997. He spent considerable time in examining the Respondent's witness regarding what has been collected by CRA in connection with the unremitted source deductions. As I tried to clarify with Mr. Kern, this Court deals with the assessment itself and not the follow-up collection matters. However, I do appreciate Mr. Kern's frustration knowing that a significant amount has been paid towards this account, without a crystal clear trail of what the amount left owing actually relates to. That however is not the purview of this Court.
[40] At issue is the underlying assessments for failure to remit an amount of $759.68 in 1999, plus the penalty of $78.96 for a total of $835.64, and for failure to remit an amount of $5,753.61 in 1998 plus interest of $1,242 and penalty of $574.35 for a total of $7,569.96.
[41] With respect to the 1998 failure to remit, of the $7,509.96 at issue, Mr. Kern only disputes $4,654.63, as the Respondent provided no supporting detail how that amount was derived. The balance was related to two specific employees: Mr. Kern accepts the Corporation's failure with respect to them.
[42] Mr. Kern also raised at his appeals the concern that the Corporation has made source deduction payments incorrectly for employees of the other company, 546, in the amount of $8,668.26. He wants to have this amount offset against the Corporation's assessment resulting in a zero liability. This I cannot do. It is one thing to allow the review of an underlying assessment on a director's liability case, but this does not provide a director the opportunity to then open issues which were not the subject of the assessment under attack. For 1998, the assessment of the Corporation pertains to unremitted source deductions tracked to two specific employees, a failure Mr. Kern acknowledges, plus an unidentified non remittance of $3,559.67 plus interest and penalties for a total $4,654.63. It is only that amount that Mr. Kern can now properly dispute.
[43] What is Mr. Kern's argument regarding the $4,654.63 in 1998 and the $835.64 in 1999? It is that the assessment of these additional amounts by the Minister is without any detailed explanation as to which employee they relate to, and in what amounts. The CRA auditor's evidence was that a "big portion of the debt was in regard to T4s being issued which were not included on the T4 summaries". Mr. Kern obtained T4 summaries from CRA. Copies of T4s were not however reproduced by either party. Mr. Kern's position appears to be that because the Minister has not produced T4s identifying exactly how the discrepancies of $4,654.63 for 1998 and $835.64 for 1999 arose, that they have failed to prove on balance the assessments were correct. Mr. Kern needs to appreciate that it is up to him to prove these assessments are incorrect; that is, to demolish the Respondent's assumptions that the Corporation failed to deduct and remit those amounts. The Corporation did not retain books and records which might have helped Mr. Kern in this regard. Indeed, I am not satisfied that the Corporation kept adequate employee records. All Mr. Kern has are the T4 summaries obtained from CRA. Can he now, under these circumstances, argue that it is up to the Respondent to provide the T4s issued by the Corporation to prove the correctness of their position? Certainly where an Appellant provides a reasonable, supportable rebuttal of a Crown assumption, the onus may shift to the Respondent to prove their position. But in this instance, all Mr. Kern can say is that he believes the Respondent is wrong. That is not sufficient to shift the onus. On balance I accept the Respondent's position that there was a shortfall in source deduction remittances in 1998 and 1999.
Conclusion
[44] Neither Mr. nor Mrs. Kern exercised due diligence sufficient to escape liability as directors pursuant to section 323 of the Excise Tax Act and 227.1 of the Income Tax Act of the Corporation's liabilities. They can however attack the underlying assessments giving rise to the directors' liability. In so doing, they have not satisfied me that the Respondent's assessments of the Corporation for failure to deduct or remit source deductions were incorrect. The Kerns' appeals pursuant to the Income Tax Act are therefore dismissed. With respect to the GST matter, the Kerns have satisfied me that the amounts set forth in Schedule "A" to the Respondent's Replies are incorrect and the appeals pursuant to the Excise Tax Act are allowed and the matters are referred back to the Minister on the basis that:
(i) The Appellants are liable for 1997 unremitted net tax of $48,161.85, interest of $2,557.47 and penalties of $3,443.61;
(ii) There are no taxes, interest or penalties for the period April 1, 1998 to September 30, 1999, for which the Appellants are liable; and
(iii) The Appellants are liable for 1999 unremitted net tax of $10,500 with interest of $1,233.65 and penalties of $1,474.82.
I make no award of costs.
Signed at Ottawa, Canada, this 5th day of May, 2005.
|
"CampbellJ. Miller" |
Miller J.
Schedule "A"
Business Name: 457189 B.C. Ltd.
|
Period |
To |
Tax |
Interest |
Penalty |
Total |
|
|
|
|
|
|
|
|
October 1, 1997 |
December 31, 1997 |
$ 48,161.85 |
$ 2,557.40 |
$ 3,443.61 |
$ 54,162.86 |
|
April 1, 1998 |
June 30, 1998 |
$ 1,137.11 |
$ 246.09 |
$ 299.24 |
$ 1,682.44 |
|
January 1, 1999 |
March 31, 1999 |
$ 7,424.36 |
$ 331.21 |
$ 448.71 |
$ 8,204.28 |
|
April 1, 1999 |
June 30, 1999 |
$ 29,166.76 |
$ 2,242.34 |
$ 2,820.82 |
$ 34,229.92 |
|
July 1, 1999 |
September 30, 1999 |
$ 24,227.27 |
$18,939.82 |
$ 50,622.85 |
$ 93,789.94 |
|
October 1, 1999 |
December 31, 1999 |
$ 12,500.00 |
$ 1,468.64 |
$ 1,755.74 |
$ 15,724.38 |
|
|
|
|
|
|
|
|
Totals |
|
$122,617.35 |
$ 25,785.50 |
$ 59,390.97 |
$207,793.82 |
|
|
|
|
|
|
|
|
CITATION: |
2005TCC314 |
|
COURT FILE NO.: |
2003-3693(GST)I, 2003-3694(IT)I and 2003-3695(GST)I, 2003-3696(IT)I |
|
STYLE OF CAUSE: |
Harald Kern and Elke Kern and Her Majesty the Queen |
|
PLACE OF HEARING: |
Charlottetown, Prince Edward Island |
|
DATE OF HEARING: |
November 22, 2004 |
|
REASONS FOR JUDGMENT BY: |
The Honourable Justice Campbell J. Miller |
|
DATE OF JUDGMENT: |
May 5, 2005 |
|
APPEARANCES: |
|
Agent for the Appellants: |
Harald Kern |
|
Counsel for the Respondent: |
Caitlin Ward and James Murphy |
|
COUNSEL OF RECORD: |
|
For the Appellant: |
|
Name: |
N/A |
|
Firm: |
N/A |
|
For the Respondent: |
John H. Sims, Q.C. Deputy Attorney General of Canada Ottawa, Canada |