Tax Court of Canada Judgments

Docket: 2000-2619(IT)G

BETWEEN:

TROM ELECTRIC CO. LTD.,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Appeal heard on August 23 and 24, 2004 at Toronto, Ontario

Before: The Honourable Justice B. Paris
Appearances:
Counsel for the Appellant:	Ian Morris Robert D. Winters
Counsel for the Respondent:	Lesley L'Heureux

JUDGMENT

          The appeal from the reassessments made under the Income Tax Act for the 1992, 1993 and 1994 taxation years is allowed with costs and the reassessments are referred back to the Minister of National Revenue for reassessment and reconsideration in accordance with the attached Reasons for Judgment.

Signed at Ottawa, Canada, this 30th day of November 2004.

"B. Paris"

Paris, J.

Citation: 2004TCC727

Date: 20041130

Docket: 2000-2619(IT)G

BETWEEN:

TROM ELECTRIC CO. LTD.,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

REASONS FOR JUDGMENT

Paris,J.

[1]      The Appellant is an electrical contractor and has been in business for approximately 25 years in the Toronto area. By its own admission, it made certain errors in reporting its income in years including its 1989 to 1994 taxation years. More particularly, the Appellant made mistakes in how it treated construction lien holdbacks that it could not collect from its customers until the expiry of a set period after the work for the customer had been completed. The Appellant deducted holdbacks owing to it at its year end and included those amounts back into income the following year.

[2]      The errors in question came to the attention of the Minister of National Revenue (the "Minister") in 1995, by which point the Appellant's taxation years up to 1991 had become statute-barred.

[3]      The Minister reassessed the Appellant for the 1992, 1993 and 1994 taxation years to correct the errors. For the 1993 and 1994 taxation years the Minister reversed both the deduction of the holdbacks and the inclusion of the previous years' holdbacks into income. However, for the 1992 taxation year he reversed only the deduction of the holdbacks. The previous year's holdback deduction that the Appellant had erroneously included in income in 1992 totalling $533,870 was left in income. The Minister says that the Appellant is estopped from now claiming that the amount was not properly included in its income in that year.

[4]      Although the Appellant has appealed from the reassessments of its 1992, 1993 and 1994 taxation years, the dispute centres on the reassessment of its 1992 taxation year. The Appellant says that the Minister is obliged to reassess to remove the amounts of the holdbacks from 1991 that the Appellant had mistakenly included in income in 1992. In the alternative, the Appellant says that if the Minister is not required to reverse the 1992 inclusion, he should not be permitted to reverse any of the holdback deductions and inclusions originally reported by the Appellant, and all of the years under appeal should be reassessed accordingly.

[5]      The main issue before the Court is whether the doctrine of estoppel is applicable in the circumstances of this case. For the reasons that follow, I find that it is not. In light of this finding, it is not necessary for me to address the Appellant's alternative argument.

Background

[6]      The holdbacks in issue arise under the Construction Lien Act[1], which requires that a customer under a construction contract hold back 10% of the amounts that are payable under the contract until 45 days after the contract has been completed or until substantial completion has been certified. Before the expiry of the holdback period any person who has supplied services or materials under the contract who has not been paid can register a lien against the property on which the work was performed. The holdbacks therefore provide protection to subcontractors and suppliers for payments that are due to them by the contractor.

[7]      As indicated above, the Appellant, by its own admission, failed to account correctly for the holdbacks which were receivable at the end of its 1989 to 1994 taxation years.

Evidence

[8]      It was not clear what led to the Appellant's mistaken treatment of the holdbacks. The evidence shows that the Appellant's accounting was quite disorganized up until about 1994. The company changed accountants near the end of 1991, and it filed amended tax returns for its 1989 to 1991 taxation years showing adjustments to sales, cost of sales, unbilled revenue and work in progress accounts. The Appellant's new accountants made an adjustment to the opening retained earnings in its financial statements in 1992 to correct a number of accounting errors, including errors in the recognition of revenue and expenses on contracts in progress.[2] Further material corrections to prior periods were made by the accountants in the Appellant's 1994 financial statements which contained the following statement:

A series of accounting errors occurred in 1991 and prior which were previously recorded as prior period adjustments. In addition, in the current year, errors made in the calculation of the percentage of completion method of revenue recognition throughout the period 1989 to 1993 were also identified. The financial statements have been adjusted retroactively for the years 1991 and prior, 1992 and 1993 to correct these errors, and to record the related income tax consequences.[3]

[9]      It is clear that the errors made by the Appellant with respect to the holdbacks was not detected at the time the amended returns for the 1989 to 1991 taxation years were filed or during the audit of those returns by the Minister. In fact, the error was only discovered in 1995 in the course of the audit of the Appellant's 1992 and 1993 taxation years. The evidence showed that the Appellant's 1991 taxation year was initially assessed on September 6, 1991 and therefore it became statute barred on September 6, 1994.

[10]     The Appellant and the Respondent each called an accounting expert to give evidence of how income from construction contracts is computed according to generally accepted accounting principles (GAAP). Both experts agreed that under GAAP there were two methods available to construction contractors for calculating income: the percentage of completion method and the completed contract method.

[11]     Essentially, the percentage completion method recognizes a portion of profit from construction contracts at the end of each fiscal period during which the contracts are ongoing. The portion of profit that is included in income for the fiscal period is based on the percentage of the job that is complete at the time, after deducting certain amounts not considered "receivable" at the fiscal period end. In contrast, the completed contract method does not recognize any profit from the contract until the end of the fiscal period in which the job is completed.

[12]     In its financial statements the Appellant used the percentage of completion method of accounting for reporting its income. In reporting income for tax purposes the Appellant used the completed contract method of accounting[4], which the Minister permits a taxpayer to do where the contracts of which the taxpayer worked may reasonably be expected to be completed within two years from the date of their commencement[5]. It was admitted by the Respondent that the Appellant was entitled to report its income this way.

[13]     In order to arrive at income for tax purposes (and ostensibly in order to convert from the percentage of completion method of accounting to the completed contract method) the Appellant made certain adjustments to the income shown on its financial statements. These adjustments included deducting holdbacks outstanding at the year end, and including the holdbacks that had been deducted at the previous year end. This is the point at which the errors in issue arose.

[14]     Both experts testified that these adjustments for the holdbacks were made in error and that the completed contract method of accounting does not permit the deduction of holdbacks that are outstanding at the year end in determining income. The Appellant therefore does not dispute that it was not entitled to deduct the holdbacks owing to it at each year end in the calculation of its income for tax purposes.

[15]     The Respondent's expert indicated in his report that under GAAP the error in deducting the holdbacks would be corrected retroactively, restating all prior years' net incomes. The specific steps required to correct the error were set out as follows:

1.          Increase the current fiscal-year's income by adding back the current year's holdback deduction that was erroneously taken.

2.          Reduce the current fiscal-year's income by deducting the prior fiscal-year's holdback deduction, which would have erroneously increased this year's income when the holdback conditions were resolved.[6]

[16]     The Appellant's expert concurred that the errors relating to the holdbacks should be corrected by reversing the deductions and inclusions in all years. He indicated that for a taxpayer using the completed contract method of accounting, the deduction of the holdbacks receivable in one year and their inclusion in income in the second year would result in an understatement of profit in the first year and an overstatement of income in the second year.

Position of the Parties

[17] The Respondent does not take issue with the proposition that, for a taxpayer using the completed contract method of accounting for income tax purposes, no deduction for outstanding holdbacks can be taken, and that corresponding inclusions of those holdbacks in income the following year is contrary to GAAP.   

[18]     The Respondent says, however, that the Appellant is now estopped from claiming that the 1991 holdback deduction was wrongly taken in 1991 and that those holdbacks were wrongly added back to income in its 1992 taxation year. The elements of estoppel, being representation, reliance and detriment, have been proved: the Appellant made a representation in its 1992 tax return by including the holdbacks outstanding at the end of 1991 as income in its 1992 tax return, the Minister relied on the representation in reassessing the amount as income in the Appellant's 1992 taxation year, and this reliance was to the Minister's detriment because the year in which the amount should have been reported (i.e. 1991) is now statute barred. Counsel says that if the reassessment before the Court is not upheld, the Appellant will escape taxation on the amount of the holdback deduction taken in 1991 because the Minister cannot reassess to add it back into the Appellant's income for 1991.

[19]     The Appellant argues that estoppel does not lie in this case because the Appellant's representation of its income was a representation of law. He cites the Supreme Court of Canada decision in Canderel Ltd. v. The Queen[7] as authority for the proposition that the determination of a taxpayer's income under the Income Tax Act is a matter of law. He says that the errors made by the Appellant in reporting its income in 1992 must be corrected by reversing both the deduction of the holdback reserve and the inclusion of the previous year's holdback reserve. The Minister is not permitted to reverse one without the other simply because the 1991 year has become statute barred. He says that the determination of income is made on a year by year basis, and that it is not in accordance with the Act or GAAP to include the 1991 reserve in income in 1992.

Analysis

[20]     Counsel for the Appellant relies on the decision of the Federal Court Trial Division in The Queen v. Wilchar Construction Limited[8] in support of the proposition that the Appellant is estopped from taking the position that the holdbacks deducted in 1991 should not be included in its income for its 1992 taxation year.

[21]     In Wilchar Construction the taxpayer had reported its income each year from construction contracts by including certain amounts that were contingently receivable at its year end. The taxpayer had consistently reported its income on this basis, but sought later to have the receivables excluded from income in the year in which they were originally included. The taxpayer alleged that according to GAAP and tax jurisprudence the amounts in question did not constitute income for tax purposes in the year in which they were reported and therefore the Minister should be required to reassess to remove them from income. The Minister refused. After the taxpayer commenced its appeal of that reassessment, it also sought to exclude other receivables from income on the same basis as the amounts originally put in issue. By that point the year in which the taxpayer alleged these new amounts should have been included in income had become statute barred.

[22]     The trial judge found that the taxpayer had the option of reporting the receivables either in the year they became receivable or the year in which they were actually received. Either method of accounting for them would have been acceptable under the Income Tax Act. He went on to find that the taxpayer had not "discharged the onus on it of proving that the application of different acceptable methods to successive fiscal periods accords with generally accepted accounting principles." Therefore, on the basis that the taxpayer's original method of reporting its income to include those amounts were legally correct, he upheld the reassessments.

[23]     The trial judge also dealt, in obiter, with the question of whether the taxpayer was estopped from seeking to change its method of reporting income. He found the taxpayer was estopped, because it had made representations as to its profits for the year in question "by the consistent way in which it calculated them" and the Minister acted on those representations, and would suffer a detriment if the taxpayer were permitted to deny those representations.

[24]     The Court of Appeal upheld the trial judge's findings, and stated that there was no legal bar to estoppel because the original method of accounting followed by the taxpayer in reporting its income was not contrary to law.[9] It can be inferred that, had the method chosen by the taxpayer resulted in a representation of his income that was not in accordance with the Act, and thereby contrary to the law, estoppel would not have arisen.

[25]     In the case before me I find that the Appellant's calculation of its income in its 1992 tax return was not made in accordance with the provisions of the Income Tax Act and specifically with section 9 of the Act, which requires the determination of an accurate picture of a taxpayer's profit. It is admitted by the Respondent that the profit reported by the Appellant for 1992 was not accurate. The inaccuracy arose because the Appellant made adjustments to its income (in the form of the holdback deductions and inclusions) that were not in accordance with the method of accounting it was using to determine its profit.

[26]     The question of whether an amount must be included in or can be deducted from income in the determination of profit under the Income Tax Act is clearly a question of law; it involves an interpretation of the provisions of the Act and the legal principles established by the jurisprudence. Therefore, a representation by a taxpayer of his income involves interpretations of law. In Goldstein v. Canada, Bowman, A.C.J. reviewed the question of estoppel in relation to representations of law and made the following comments:

...Although estoppel is now a principle of substantive law it had its origins in the law of evidence and as such relates to representations of fact. It has no role to play where questions of interpretation of the law are involved, because estoppels cannot override the law...

...[C]ourts, who have an obligation to decide cases in accordance with the law, are not bound by representations, opinions or admissions on the law expressed or made by the parties.[10]

The rule that estoppel cannot override the law is applicable in this case. Since the Minister's reassessment of the Appellant is contrary to law the Appellant cannot be estopped from challenging it.

[27]     The fact that the Appellant may escape taxation on the amount in issue in this appeal unless the reassessment is upheld is not relevant. It cannot be used as a justification for a reassessment that the Minister does not have the power to make under the Income Tax Act. In another case on this point, Dussault J. stated:

The Minister has no power to assess a taxpayer in the year of his choice when he did not do so for the year in which he was required to do it under specific legislative rules. Allowing him to do this would be to give him a legislative power or discretion which he does not have.[11]

[28]     Furthermore, the Appellant would only escape taxation on this amount through operation of the Income Tax Act, if the limits placed on reassessments in subsection 152(4) are applicable to the Appellant's 1991 taxation year, or if the Minister chooses not to reassess for that year.

[29]     In summary, the Appellant is not estopped from claiming that the holdbacks outstanding at the end of its 1991 taxation year were wrongly included in income in its 1992 taxation year, and the Minister is ordered to reassess the Appellant's 1992 taxation year to remove that amount from income. The appeal is therefore allowed with costs.

Signed at Ottawa, Canada, this 30th day of November 2004.

"B. Paris"

Paris, J.

CITATION:

2004TCC727

COURT FILE NO.:

2000-2619(IT)G

STYLE OF CAUSE:

Trom Electric Co. Ltd. and H.M.Q.

PLACE OF HEARING:

Toronto, Ontario

DATE OF HEARING:

August 23 and 24, 2004

REASONS FOR JUDGMENT BY:

The Honourable Justice B. Paris

DATE OF JUDGMENT:

November 30, 2004

APPEARANCES:

Counsel for the Appellant:

Ian Morris, Robert D. Winters

Counsel for the Respondent:

Lesley L'Heureux

COUNSEL OF RECORD:

For the Appellant:

Name:

Ian Morris, Robert D. Winters

Firm:

Morris & Morris Toronto, Ontario

For the Respondent:

Morris Rosenberg Deputy Attorney General of Canada Ottawa, Canada

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