Date: 19990216
Docket: 97-2481-GST-I
BETWEEN:
LADY ELLE INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for judgment
Lamarre Proulx, J.T.C.C.
[1] The appellant is appealing from the assessment made by the Minister of National Revenue (“the Minister”) under the Excise Tax Act (“the Act”) for the period from November 1, 1991, to July 31, 1995.
[2] The facts on which the Minister relied are set out as follows in paragraph 2 of the Reply to the Notice of Appeal (“the Reply”):
[TRANSLATION]
(a) the appellant is a supplier registered for the purposes of the Excise Tax Act, R.S.C. 1985, c. E-15, as amended (ETA);
(b) during the period at issue, the appellant operated a business selling women’s lingerie;
(c) during the period at issue, the appellant failed to record all of its sales in its cash register and to enter them in its records;
(d) the appellant failed to collect and remit GST on the unreported sales and to remit the GST collected on some sales;
(e) a tax investigation revealed that the goods purchased for sale were resold at a price that was, on average, 78.07 percent higher than their acquisition cost;
(f) by increasing by 78.07 percent the cost of the goods purchased by the appellant for resale from November 1, 1991, to April 30, 1994, the auditor estimated that the unreported GST on the appellant’s sales totalled $6,057.28;
(g) no financial statements were available for the periods from May 1, 1994, to January 31, 1995, and May 1 to July 31, 1995, so the auditor extrapolated from the data on unreported GST from previous years to determine that the unreported GST for these periods totalled $5,773.12;
(h) for the period ending April 30, 1995, the appellant mistakenly reported $13,257.83 as collectible GST, whereas $933.86 was entered in its accounting records, and the reported amount was reduced by an input tax credit of $12,195.38, which was re-estimated at $1,449.44 following the audit;
(i) the appellant also failed to remit the GST it collected on making certain taxable supplies that it did not report;
(j) the net tax that the appellant should have reported and remitted for the period at issue was $7,082.79; and
(k) since the appellant reported net tax credit balances totalling $4,609.31 during the period at issue, the respondent, through the assessment at issue, claimed $11,692.10 as unremitted net tax, with interest and penalties;
the whole as will be more fully shown at the hearing with the worksheets appended to the audit report;
[3] Paul Thomas, the appellant’s principal shareholder, testified at the request of the agent for the appellant, Robert Lescouflair, the accountant who prepared the appellant’s financial statements. Lucie Lacroix and Benoît Denis testified at the request of counsel for the respondent.
[4] At the time of her investigation in 1996, Ms. Lacroix had been a tax auditor for Revenu Québec since November 1990.
[5] Ms. Lacroix explained that, as noted in subparagraph 2(h) of the Reply, the appellant applied for a $5,790.97 tax rebate for the period from February 1 to April 30, 1995 (Exhibit I-2). After the application was received, a tax audit of the appellant was conducted since, as is shown by Exhibit I-3, the appellant was claiming a much greater amount than usual.
[6] Exhibit I-3 is a working document containing a table on the goods and services tax collected by the appellant and the input tax credits it claimed. It shows that, from January 31, 1992, to April 30, 1995, the net tax balance was always negative by an average of between $300 and $500. It was when a net tax claim of $5,790.97 was made that the business was audited.
[7] Ms. Lacroix phoned the appellant to ask to see the sales journal and all of the sales books. Ms. Gagliardi, Mr. Thomas’ spouse, answered for the appellant. The Minister’s officer said that, based on her discussion with Ms. Gagliardi, she considered her to be the manager of the business. Ms. Gagliardi told her that she could not come to the business premises because they were too small but that she could go to the office of a David Haimovitch, where all of the accounting records were kept. The auditor thought that Mr. Haimovitch was the accountant and would be able to answer her questions, but he was not and was therefore unable to answer any questions.
[8] Neither Ms. Gagliardi nor Mr. Thomas was present when the auditor went to Mr. Haimovitch’s office. A few days later, the auditor went to the appellant’s store, this time without warning. A customer was being served, and Ms. Lacroix waited about 10 minutes, looking at the merchandise. The sale to the customer was made in cash and was not recorded in the cash register. Ms. Lacroix introduced herself and asked Ms. Gagliardi whether it was common for her not to record sales. Ms. Gagliardi said that it was. According to Ms. Lacroix, Mr. Thomas told her the same thing, explaining that the total of the appellant’s sales had an impact on the rent it paid. In his testimony, Mr. Thomas said indignantly that he certainly had not made this comment, since it made no sense.
[9] Ms. Lacroix said that most of the cash register tapes were not legible and that, since she had seen an unrecorded transaction, she decided that there was no point in using the tapes for her audit and that, in any event, it was impossible to do so. She therefore proceeded on the basis of estimates.
[10] She had a few purchase invoices and the corresponding sales invoices at her disposal. Based on the acquisition cost and the sale price indicated on those invoices, she calculated a mark-up rate of 78.07 percent. She also compared the price of the purchased goods with the prices shown on the tags at the time of her visit on July 6, 1995. For those prices, she calculated a mark-up rate of 100.44 percent. She then compared the purchase price of a few goods with the manufacturer’s suggested price to calculate a mark-up rate of 89.08 percent. Since the mark-up rate was lower for the goods whose sale was recorded on an invoice, she used that mark-up rate for the purposes of her assessment. Her report was filed as Exhibit I-4.
[11] To make her assessment, Ms. Lacroix then relied on the acquisition cost of the goods sold or the “cost of sales” as shown in the financial statements. She applied the mark-up rate to the cost of the goods sold as set out in the appellant’s financial statements for the first few years at issue. The financial statements for the 1991-92, 1992-93 and 1993-94 fiscal years, which ended on April 30 of each of those years, were filed as Exhibit I-1. As noted in subparagraph 2(g) of the Reply, the financial statements for subsequent years were not available. The auditor extrapolated based on the data from previous years.
[12] Exhibit I-5 is the portion of the auditor’s report that concerns the amount of tax to be collected on the estimated sales.
[13] Mr. Thomas explained that it was he who testified for the appellant rather than his spouse, Ms. Gagliardi, because he owned the appellant and was the one who knew the financial side of the business. He began his evidence by filing the appellant’s unaudited financial statements for the years ending April 30, 1995, and April 30, 1996.
[14] According to the financial statement for the fiscal year ending April 30, 1995, gross sales totalled $75,434.82 and the cost of sales was $57,235.59. This means that the mark-up rate was about 30 percent, the cost of sales ratio more than 80 percent and the gross profit ratio about 20 percent. The other financial statements show the same ratios for the cost of sales and the amount of gross sales.
[15] As Exhibit A-2, Mr. Thomas filed the appellant’s lease with the Centre commercial Côte St-Luc Ltée for the premises the appellant used for its lingerie store. It is dated April 26, 1991, and the expiry date is April 30, 1996. Mr. Thomas directed the Court’s attention to clause 17.2 of the lease, which concerns the consequences of default by the lessee. He explained that, because of these provisions, which made it impossible to terminate the lease before the completion of its term, he had to continue operating the business even if it was not profitable.
[16] Similarly, as Exhibit A-5, the appellant filed a rent reduction application it made to the lessor on October 28, 1992, which was denied.
[17] A sales book was filed as Exhibit A-8 and a few purchase invoices were filed as Exhibit A-9. The appellant’s agent asked Ms. Lacroix how she was able to correlate the goods purchased with the goods sold on the basis of the invoices, which identified the goods sold in very brief terms. She answered that she had correlated the two only in cases where she was sure.
[18] Five of the business’s books, which were used to record purchases and sales, were filed as Exhibit A-10.
[19] As Exhibit A-11, Mr. Thomas filed a handwritten summary of sources of income other than the store, because it seemed to him that this was the main point raised by the Minister’s officers: they had told him that he could not live for several years in a row with a business that was incurring substantial losses.
[20] The Court asked Mr. Thomas a few times what mark-up rate his business used in selling goods. He did not want to answer. He said that he was not an accountant. At other times, however, he said that he was a good administrator.
[21] As Exhibit A-7, Mr. Thomas filed a document prepared by his accountant, Robert Lescouflair, who also acted as the appellant’s agent at the hearing. The document is a reply to the Revenu Québec auditor’s preliminary report. It states the following at page 8:
[TRANSLATION]
As a precautionary measure, following a visit to and a check with Statistics Canada (Guy Favreau Complex in Montreal), we have found that, for women’s clothing retail stores, the average ratio of the cost of sales to gross sales was about 59 percent in Canada from 1991 to 1994. If the ratio is 59 percent, then the ratio of gross profit to gross sales can be deduced to be 41 percent. The ratio for net sales (gross sales, discounts) would be even lower.
[22] This statement, which contradicts the accountant’s own figures as set out in the financial statements, confirms the Minister’s position. The cost of sales ratio is 56.16 percent according to the auditor and 59 percent according to Statistics Canada, but it is 80.76 percent according to the financial statements. The gross profit ratio is 43.82 percent according to the auditor and 41 percent according to Statistics Canada, but it is 19.24 percent according to the financial statements.
[23] It is my opinion that the auditor correctly determined the amount of gross sales and therefore the amount of the tax by taking the cost of sales referred to in the financial statements (an amount that was not disputed by the appellant) and increasing it by the mark-up rate of 78 percent, which was consistent with the cost of sales ratio and the gross profit ratio established by Statistics Canada. In my view, the 30 percent mark-up rate indicated by the financial statements over a period of more than five years has no possible commercial basis, since the mark-up must be what is needed to pay all of the business’s operating expenses and generate a profit.
[24] It is hard to believe that Mr. Thomas, who claims to be a good administrator, had no idea of the mark-up rate used in the appellant’s business even though he was the sole shareholder and president of the appellant. It seems to me that this is a basic concept in the retail trade. I am inclined to believe that in refusing to answer this question on the pretext that he is not an accountant, Mr. Thomas did not answer candidly.
[25] Since the Minister’s position is the one that is most consistent with reality, since it is based on objective information, such as the mark-up rate and the cost of sales determined using the appellant’s own documents, and since no reasonable explanation was given by the appellant, the appeal must be dismissed.
Signed at Ottawa, Canada, this 16th day of February, 1999.
"Louise Lamarre Proulx"
J.T.C.C.