Date: 19991116
Docket: 97-2965-IT-G
BETWEEN:
CONTINENTAL STEEL LTD.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Margeson, J.T.C.C.
Statement of Agreed Facts
The parties hereby agree that for purposes only of this Appeal and any appeal therefrom or any other proceeding taken in this matter, the facts set out herein are true. No evidence inconsistent with this Statement of Agreed Facts may be adduced at the hearing of these Appeals or at any appeals therefrom but additional evidence, not inconsistent with this Statement of Agreed Facts, may be adduced by either party.
1. The Appellant is a company incorporated under the laws of the Province of British Columbia on July 17, 1975.
2. The Appellant's principal place of business is 251 Schoolhouse Street, Coquitlam, British Columbia.
3. At all material times, the Appellant had a fiscal year end of June 30.
4. In filing its income tax return for its 1988 taxation year, the Appellant reported net income of $481,133.00.
5. The Minister of National Revenue (the "Minister") initially assessed the Appellant for its 1988 taxation year by Notice dated March 28, 1989.
6. The Minister reassessed the Appellant for its 1988 taxation year by Notice dated February 2, 1996 (the "Reassessment").
7. In reassessing the Appellant for its 1988 taxation year, the Minister added unreported revenue to income as follows:
Previous Net Income $481,133.00
Adjustments to Active Business Income
Add: Revenue understated $201,500.00
Revised Net and Taxable Income $682,633.00
The Minister also levied penalties under subsection 163(2) of the Income Tax Act (the "Act") and subsection 23(2) of the British Columbia Income Tax Act in the amounts of $29,056.30 and $14,611.50, respectively, for total penalties of $43,667.80.
8. The Appellant objected to the Reassessment by Notice dated March 2, 1996 on the basis that the Reassessment was statute-barred.
9. The Minister confirmed the Reassessment by Notice dated July 4, 1997.
DATED at the City of Vancouver, British Columbia, this 20th day of October, 1999.
Issues
[1] There are two main issues in this matter. 1) Was the reassessment for the year 1998 statute barred under section 152(4)(a)(i) of the Income Tax Act (the “Act”)? 2) Was the Minister justified in assessing additional penalties under subsection 152(2) of the Act?
Evidence produced at trial
[2] David A. Lloyd testified that he was a professional engineer and a business man. Through him a book of documents was admitted by consent and marked Exhibit R-1. The witness said that he was the president of the Appellant’s company, its sole shareholder and in essence its operating mind. He had considerable business experience and had received a master’s degree from the University of London on the Scientific Side of Management. His business experience expands some 36 years. He was the former general manager of Great West Steel which had over one hundred employees. He had an interest in other companies as well. He understood the concepts of profit/loss, gross and net income and inter-company accounts.
[3] The business of Continental Steel Ltd. (the company) was essentially to supply steel framework for new buildings. It was incorporated by this witness, he was the president, sole director and shareholder since the incorporation. He also managed the day-to-day operations of the company. He was a hands on manager. He was in charge of hiring and firing newer office personnel although ordinary workers were hired and fired by others. During the years in question he had hired accountants and bookkeepers. In the year in question the company had 30 to 40 employees, the bookkeeper was one Kathleen Nelson.
[4] He said the trial balances were normally provided to him at month’s end but not always. There were a few months when he did not receive them. He knew how the business was doing.
[5] In the year 1988, Warren MacKenzie was the Company accountant. The witness reviewed a draft financial statement with him as he was preparing it. He did not recall instructing the accountant to make any changes although they may have discussed the reasoning for any particular items.
[6] In evidence he said that he met the bookkeeper daily. He was then referred to evidence given by way of discovery on August 30, 1999 and admitted that he had said that he did not have time to sit down with the bookkeeper to review business.
[7] He was referred to Exhibit R-2 at tabs 1, 2 and 3 which were the income tax returns of the Company. He identified the 1988 return and said that it should have included the amount in issue in this case. He signed that return. He spent time with the accountant when he was preparing it. He was referred to his discovery evidence again and he agreed that he had said that he probably just signed it and did not review it. He believed that the accountant had included in the return, any changes that they had discussed. He signed the affirmation in the return that it was correct.
[8] He has referred to discovery evidence given on August 31st, where he said that Kathleen Nelson prepared the information and gave it to the accountant and that she worked for him. He agreed that the net income figure shown in line 111 of the Company's return for the year 1988 was not correct. This amount should have included the disputed amount. He added that there were also other expenses which should have been claimed and which were not included in the figures in this return.
[9] He did not question the accountant about whether or not the disputed amount was included in income. He merely presumed that it was. There was no audit done in the years in question and that was his decision. The same thing applied to the year end 1993. In that year the data was supplied by Leslie Hill.
[10] He was referred to the Company by the name of Mountwest Steel Ltd.. It was incorporated by him and he was the president and sole director and was a 50% shareholder in this Company. This Company was initially incorporated for the purpose of obtaining relief from provincial sales tax but it was not used for that purpose.
[11] In essence Mountwest received steel from Continental and sold it directly to customers. At the year end it was determined what steel was taken and the books would be adjusted and an invoice made out to reflect this amount. The amount in issue in this case was the amount of steel that Mountwest took from Continental for the year 1987. This was the end of the 1987 fiscal year for Mountwest and the beginning of the 1988 year for Continental. Mountwest had bookkeepers only and no year end accountant. This decision was made by this witness.
[12] He did not record amounts in the books of the Appellant Company. This was done by other employees. In the latter 1980s Continental Steel encountered severe bookkeeping problems beginning around May 1988. They went through several bookkeepers until Leslie Hill was hired in January of 1990.
[13] He was referred to tab 7 of the Respondent's Book of Documents which was a summary that he had prepared to reflect the changes in bookkeepers and some of the problems in bookkeeping that the Company encountered. He said that Debbie Cooke had forgotten to enter the amount of $201,500.00 in Continental Steel's books. He was referred to a note prepared by him on July 31, 1988 and he said that this indicated that he had told Kathleen Nelson to enter the amount in question in the Company's books. He admitted that the note did not specifically instruct anyone to enter these items and record these amounts but he said that he would have given her these instructions verbally. He did not remember if he gave her this particular document.
[14] In September 1999, Debbie Cooke brought a document to him and told him that Kathleen Nelson had not entered the disputed amount so that is why he must have told her to do it and must have given her the information. Kathleen Nelson did not enter any of this information in the books of this Company.
[15] He presumed that the bookkeeping was being done properly. He did not check to see that the work was being done properly. No reconciliation was done of the accounts for these two companies. He gave Debbie Cooke written instructions to enter the same transactions for the next year as he gave orally to Kathleen Nelson for the year in issue. He instructed Debbie Cooke to make similar entries for the next year and she discovered that Kathleen Nelson had not made the entries for the year in question in both companies' books. He then told Debbie to enter it in Continental Steel books as if it has been recorded in 1989. He admitted that there was no entry in Continental Steel’s books for the amount in 1989 and there was no indication that this correction had been made. He did not give instructions to enter this amount. Debbie did not enter it in Continental Steel’s books but did enter it in Mountwest Steel’s books. He admitted that Mountwest Steel received the benefit of the expense.
[16] In August 1993, he became aware that it had not been entered in Continental Steel’s books. He had an argument with the Company accountant as to whether or not Debbie had looked after it in 1989 and the accountant told him that she had not.
[17] When he was advised that it was recorded in the 1993 year end and in Continental Steel’s books the accountant had told him that the year was statute barred and that he was going to cancel the entry. The reconciliation in 1992 which was done by Leslie Hill recognized the error that had been made. In 1988, he had never asked the Company accountant to do a reconciliation as a routine procedure.
[18] He referred to the notes made to the financial statements of the Appellant’s Company for the year end 1993, which were referred to as prior period adjustments and in essence said that he had believed that the accountant had made the right recommendation as to how to handle the error although the note itself does not refer to the amount in issue. There was no amended financial return nor notes made to the 1988 return.
[19] He was referred to tab 9 of Exhibit R-1 which was a review engagement letter from W.F. MacKenzie for the company. This letter had some changes made to it by this witness and the reason for it according to the witness was "I was being a cheap skate. I did not want him to hire a bookkeeper to do the work that I had already hired a bookkeeper to do".
[20] He indicated that he discussed the documents with his accountant before finalizing them and then the accountant finalized them. His engagement terms with the accountant were cheap on his part but were also careful on his part.
[21] In cross-examination he said that he is responsible for everything that happens at Continental Steel. Mountwest Steel and Continental Steel are unrelated companies for income tax purposes. He discussed some of the personal problems that Kathleen Nelson had and said that she was worried and concerned. It affected her work. She took time off. She had to leave work as she was incapable of working full time. She came back and worked part time. He said that "I believe that I gave the document in writing to correct the entries in both companies books. I assumed that it had been done." After he saw the document again that he had written he had no reason to believe that the entries had not been done until the summer of 1989 when Debbie brought it to his attention. He was asked what he could have done to have prevented the error and he said that he could have followed up on it, but it was not part of his regular routine. He could not follow-up on every instruction that he gave. He believed that all transactions had been properly entered in the years in question and that all of his instructions had been followed.
[22] He was referred to the income statement for the company for the year ending June 30, 1988, particularly the revenue account and he said that the addition of the disputed amount would have increased the revenue figure. The amount should have shown up on the inter-company loan accounts but he was not exactly sure where it should be in the statements. However, he believed there was something else wrong with the inter-company loan entry since there should have been a big difference between 1987 and 1988 and there was not.
[23] When the discovery was made by the accountant he was told that a prior period adjustment had to be made only for the year that was being presented. In 1989, Debbie told him that Kathleen had not made the appropriate entries for both companies. Until then he had no idea that anything was wrong. He told her to fix them all. At that time he knew that he was including the 1988 income in the year 1989. There should have been two entries made in each company’s books. It would not have netted out for tax purposes. As far as he was concerned, in sending out the document at tab 4 to Debbie Cooke, he was instructing that the entries be made that had to be made to correct the error.
[24] He may have sent the cheque in to Revenue Canada before each return was actually completed. Income was up considerably over 1987 income and he must have believed that the disputed amount had been included. He could not have found the error by reviewing the financial statements. If the income had been down over 1987 income he would have seen a problem but it was not. He would not have seen any problem in the amount of tax owing because it was up considerably over 1987.
[25] It was his position that before the accountant came to see him he was not aware of any reconciliation problem. The Appellant was never asked for an audit. He avoids audits because they are too expensive and they do not necessarily provide any advantage. He never made any journal entries for either company. As far as he was concerned when he discovered the error he instructed that the necessary entries be made. In his mind the amount filed in the return was correct.
[26] According to him Leslie Hill was very careful. Debbie Cooke was there only for a short period of time. Her work was problematic. She was irresponsible and had a number of personal problems. She quit. Leslie Hill was careful and Debbie was not. When he signed the return he would not have gone over it at that time. If there had been any surprise in the amount of taxes owing over the previous year the accountant might go over it with him. In late January 1988 he gave financial information to Kathleen Nelson for that year and asked her to make the entries in the books of both companies. In his mind it had been done.
[27] In 1992 when Debbie Cooke brought the error to his attention he then told her to make all entries. In 1993 he was told that prior financial statements need not be changed but only for that year. He still does not follow-up on normal entries. He has not changed his personal procedures since this problem developed. He was told that the only way that the mistake would have been picked-up would be if reconciliations had been done and that is now being done.
[28] In re-direct he reiterated that the 1987 Mountwest Steel return was correct in all respects as far as he was concerned when it was filed. Again he confirmed that in 1988 it was his decision not to have the reconciliation done or an audit done. In each year he records the amount of steel obtained from the Appellant company by Mountwest Steel.
[29] Leslie Ann Hill was employed by the Appellant' company doing internal bookkeeping work for it and two other companies for Mr. Lloyd. She started working in January 1990 and was hired by David Lloyd. She took Bookkeeping 11 and Accounting 12 at night school and also took another courses at the British Columbia Institute of Technology. She has no official designations. At the time of her hiring she had high school courses. She never worked with any company accountants before that time. She did not know about reconciliations. She did trial balances and year end entries for both companies. She gives the trial balance to Mr. Lloyd at the end of every month. She found him very knowledgeable about business and the activities of the companies. They did not meet very often. She handed the work to him but they did not have a planned meeting schedule.
[30] She recognized that the accounts did not balance after a certain period of time. One of the bookkeepers was not keeping the records up to date. She did not remember when she made the discovery but it was probably six months before she did the changes. She discovered the error because she did a reconciliation of the inter-company accounts. It was her idea. Her normal procedure was to review them if they are not in agreement. She does the reconciliation now as part of her regular procedure.
[31] She noticed that there were quite a few errors by previous bookkeepers. Her position was that the error might be easy to miss since this type of reconciliation had not been done before. It took her about a full day to complete the reconciliation. In July 1989 the entry was made in Mountwest Steel’s books. It should have been recorded in 1987 but it was not recorded until 1989.
[32] It was her position that if the accountant had looked at the inter-company accounts he would have known that something was wrong. In July 1992 she made the journal entry in Continental Steel’s books. She did not think that it was a big deal. She did not notify anyone.
[33] In cross-examination she said that when she found the error, "it did not jump out at her”. She found all of the errors referred to in Exhibit R-1 at tab 5. The year end journal entries only were in error. The steel purchase books for both companies were correct. If she had made such errors she would have found them on a reconciliation of accounts. She was never told by Mr. Lloyd to reconcile the accounts and he did not tell her not to. When she was working on the books she just knew that they were not correct. Mr. Lloyd did not know that she was doing this reconciliation. The error was caused by someone being careless but mistakes do happen. It could have been that there were different bookkeepers there over the period.
[34] In re-direct she said that the entries made in Exhibit R-1 at tab 5 were all entries that had to be made in Continental Steel’s books. She agreed that in her discovery evidence given in 1989 she had said that Mr. Lloyd was not a "meeting person" and that he found it a waste of time. If a reconciliation had been done in 1988 the error would have been found.
[35] Warren MacKenzie was a certified general accountant and has been so since 1982. He is the external accountant for the Appellant company. He referred to an engagement letter that he sent to Mr. Lloyd, found in Exhibit A-1 at tab 3, on June 24, 1988 for the 1988 year end. He received a note back from Mr. Lloyd questioning the terms of the engagement. He agreed to make amendments to the engagement. He believed that Mr. Lloyd misunderstood the term bookkeeper. He did not intend to do simple administrative bookkeeping which is normally done by a bookkeeper or by someone on the staff. He did the income tax return for Continental Steel Ltd. for the year 1988. He was not aware of the disputed amount. He also did the financial statements for Continental Steel Ltd. In completing the note 11 in the notes to the financial statement, he believed that he had complied with generally accepted accounting principles and CIC guidelines. The net effect of the year was that the 1993 income for Continental Steel was increased. The amount stated was not correct but there were also expenses which were incorrect which had occurred in other years.
[36] In 1989 he was aware that there were bookkeeping problems in the Appellant company. He filed the income tax return with the appropriate notes. He asked the bookkeeper to continue to look for errors. This was Debbie Cooke. In 1990 it was obvious that no additional work had been done to find the errors in the accounts receivable and the accounts payable. Leslie Hill was the bookkeeper and she did not know what work was done before. He knew that they were not going to find the problem shortly so he filed an amended return. There was no problem in the years 1990 and 1991. He was familiar with inter-company accounts and he knew that Leslie Hill had done an inter-company account reconciliation which led to his preparing note 11.
[37] When he does not do an audit he does only a random check of transactions. If he had done an audit in the year in question he would not necessarily have discovered the error. In the year 1989 he switched to a review engagement procedure because the banks were asking for a greater degree of inquiring of the client's transactions even though they were not requiring an audit. An audit would be a way of giving more assurance. The amount of money in issue here would be marginally material and represented about 3% of sales. He considered Leslie Hill and Mr. Lloyd to be careful persons.
[38] His procedure was to “walk a person through the tax return and highlight certain areas”. The typical client would meet with him and discuss the draft financial statements and the tax returns. Then he would finalize the returns and statements or make the necessary changes to them as a result of the meeting. The client would assume that he had made the necessary changes if the final return was basically the same. As far as he was concerned there was nothing in the financial statement for the year in question that “would jump out at Mr. Lloyd to suggest that the $201,500.00 amount was not included".
[39] In re-direct he said that in the year 1988 he conducted the first level of review from information obtained from the bookkeepers. Mr. Lloyd decided that this was a level of review that he wanted. Where there are inter-company accounts it is not normal to do a reconciliation of these accounts. He did not recommend it and he was not asked about it. In September of 1993 he became aware of the problem. He talked to Leslie Hill about it and made the prior year adjustment.
[40] He admitted that note 11 does not refer to the specific amount of $201,500.00. No specific mention was made that this amount should be added on to the return. No amended return was filed for 1988. His engagement was not to detect fraud or error. In the case at bar the taxpayer profited from the error in the fact that the taxation year was statute-barred. This is just the other side of the coin but often it is the taxpayer who suffers from such an error when the Minister will not allow the return to be refiled.
[41] In 1988 he was attempting to increase the level of engagement but he did not receive the signed engagement letter back from Mr. Lloyd. He proceeded on a note to reader basis.
Argument on behalf of the Respondent
[42] In argument counsel confirmed her position that there were two basic issues in this case. The first issue was with respect to the right of the Minister to assess after the expiry of the normal assessment period. In accordance with the provisions of subsection 152(4) of the Act both parties agreed that under the circumstances of this case there was a misrepresentation and the only question under this subsection was whether or not the misrepresentation was attributable to neglect, carelessness, wilful default or fraud on the part of the Appellant.
[43] On the second issue with respect to the penalties, the appropriate wording of subsection 163(2) during the year in issue was as follows:
2) False statements or omissions
Every person who, knowingly, or under circumstances amounting to gross negligence, has made or has participated in, assented to or acquiesced in the making of, a false statement or omission in a return, form, certificate, statement or answer (in this section referred to as a “return”) filed or made in respect of a taxation year for the purposes of this Act, is liable to a penalty of the greater of $100 and 50% of the total of ---
Counsel referred to the case of John G. Nesbitt v. The Queen, 96 DTC 6045 in support of her position that a misrepresentation under the appropriate section is basically the same as an incorrect return. This was not contested by Counsel for the Appellant.
[44] In the same case, John G. Nesbitt v. The Queen, in the Federal Court of Appeal, 96 DTC 6588 at page 6589 the Court said:
". . . It appears to me that one purpose of subsection 152(4) is to promote careful and accurate completion of income tax returns. Whether or not there is misrepresentation through neglect or carelessness in the completion of a return is determinable at the time the return is filed. A misrepresentation has occurred if there is an incorrect statement on the return form, at least one that is material to the purposes of the return and to any future reassessment."
[45] In Venne v. The Queen, (1984), 84 DTC 6247 at 6251 the Court equated the word "misrepresentation" as attributable to neglect as meaning negligence to the extent that the taxpayer has not exercised reasonable care in the filing of the return. The Court concluded that the term "neglect" requires a lesser standard of deficiency than that required in the law of negligence.
[46] Counsel referred to the case of Can-Am Realty Limited et al. v. The Queen 94 DTC 6293 at 6300 and argued that the facts in that case were similar to the case at bar. There the taxpayer had no accounting qualifications himself and assumed that all accounting matters were being accurately looked after by his bookkeeping personnel. He had no cause to believe that anything was wrong. This, it was argued, was sufficient to exclude the operation of the appropriate section. However, the Court did not agree and found that where the taxpayer was a knowledgeable business man, controlled the day-to-day affairs of the company, and where its bookkeepers did not carry out their functions with due care and attention, the Court found that the taxpayer was not absolved from responsibility for the errors contained in the returns filed.
[47] In the case at bar counsel argued that Mr. Lloyd managed the company, knew that the bookkeeping staff was having problems, assumed that they were doing their jobs, did no follow-up to see that the work was being done satisfactorily, did not instruct the accountant to do any bookkeeping, set-up a system in which the bookkeeper was responsible to make the entries but yet had no system in place to ensure that this was done. There was a list of mistakes that were not discovered due to the fact that no reconciliation of accounts was performed.
[48] It was counsel's position that indifference alone may be sufficient to bring into play the appropriate provisions with respect to misrepresentation. She referred to the case of Halim Saikali v. The Queen 98 DTC 2249 at page 2254 in support of this proposition. This case was upheld on appeal.
[49] Counsel addressed the issue of whether or not the mistake of the bookkeeper or bookkeepers in the case at bar was tantamount to being the mistake of the company and referred to the case of The Queen v. Columbia Enterprises Ltd., 83 DTC 5247 at 5249 where the taxpayer left all matters relating to the return and the contents of the return to the sole discretion of his accountant and made no attempt to control the actions of the accountant. The Court found that the actions of the accountant where the actions of the taxpayer and the Court distinguished that case from Udli v. The Minister of National Revenue 70 DTC 6019.
[50] In the case at bar counsel argued that the actions of the bookkeepers were the actions of Mr. Lloyd and of the Appellant's company. These actions amounted to a misrepresentation under the appropriate section, and the company is liable for those actions. There were no clear instructions issued to the bookkeepers for 1998. The instructions were verbal at best. The bookkeeper had substantial personal problems and Mr. Lloyd did not follow-up to see that his instructions were followed or that the work was completed by the bookkeeper. He decided on the lowest level of review in 1988 and hired people who had no experience.
[51] In the case at bar there was a double error in not recording the entries in the proper books of the two companies. Mr. Lloyd knew before the year was statute-barred that the entries were not made, then the second time around he did not check to see if the entries were made in the Appellant's books. There was a long pattern of mistakes, there was no follow-up and several of the bookkeepers were known not to perform their work satisfactory.
[52] On the first issue the Minister was entitled to assess beyond the normal assessment period. The Minister's assessment in that regard should be upheld.
[53] On the issue of penalties under subsection 163(2) Counsel referred to the case of Lucien Venne c. The Queen, 84 DTC 6247 at 6255 where the Court referred to the interpretation of Cattanach, J. In Udell v. MRN (1969), 70 DTC 6019 (Ex. Ct.) where a farmer was relying upon a certified public accountant to prepare his income tax returns. Several errors were made in different taxation years in transposing the figures from the taxpayers' books of account to the accountant's working papers. In some years the accountant had signed the returns on behalf of the taxpayers before they were even seen by him and in other years the taxpayer reviewed them first and then signed them. The learned judge found that the relevant information contained in the returns provided by the accountant which amounted to gross negligence was not the gross negligence of the taxpayer. The Court in that case was interpreting restrictively the penalty provision in Venne (supra). The Court also considered the burden of proof that was on the Minister in justifying the assessment of the penalty. In Venne (supra) the Court was not satisfied that the Minister had met the burden and he was not entitled to apply the penalties.
[54] Counsel argued that the amount involved in the case at bar was not an insignificant amount as in the case of Patricio v. The Queen, 84 DTC 6413. When discrepancies are large it is more difficult to believe that a taxpayer could have inadvertently failed to see the discrepancy even if he were relying entirely upon his accountant. Therefore, larger discrepancies may lead to a conclusion that there was gross negligence even though these discrepancies need not be large to be gross negligence.
[55] In the case at bar Counsel for the Respondent has met the burden of proving that the actions of the Appellant amounted to gross negligence and the penalties were properly assessed. She submitted that the appeal should be dismissed on both grounds and the Minister's assessment confirmed.
Argument on behalf of the Appellant
[56] Counsel for the Appellant submitted that in order for the reassessment to be allowed after the normal reassessment period has expired the neglect, carelessness, wilful default or fraud on the part of the taxpayer must amount to negligence. He referred to Jet Metal Products v. MNR (1979), 79 DTC 624 (T.R.B.); MNR v. Bisson (1972), 72 DTC 6374 (F.C.T.D.) and Tardif v. MNR (1979), 79 DTC 758 (T.R.B.).
[57] Counsel pointed out that the Jet Metal Products (supra) decision was quoted with approval by the Trial Division of the Federal Court in Venne (supra) and that even though Mr. Justice Strayer found that the taxpayer should have realized that he had more tax to pay in the year in question because the cash on hand in some years was increasing by more than his entire reported income for the same year end. If he had read his returns it would have been obvious to him that he should have questioned his bookkeeper. Therefore he allowed the Minister to re-open the statute-barred years but he did not find that this amounted to gross negligence which would enable the Minister to levy penalties.
[58] Counsel quoted with approval the reasoning of Mr. Justice Rouleau in Can-Am Realty Limited et. al. (supra) where the Court appeared to equate the term carelessness to negligence and he did not find that such negligence existed. Counsel referred to Snowball v. The Queen (1996), 97 DTC 512 (T.C.C.) where Judge Bowman based the negligence of the taxpayer on his assumption that the income was included in the taxpayers' return without taking adequate steps to ensure that it was in fact there.
[59] Counsel submitted that in accordance with the reasoning in Bisson (supra), that
"When the Minister seeks to rely on this provision to proceed with a reassessment after four years, he must therefore not only show that the taxpayer committed an error in declaring his income but also that that error is attributable to negligence on his part."
[60] That test he argued is whether or not the error was one which a normally wise and cautious taxpayer could have committed. In the case at bar that equates to question as to whether or not it would have been reasonable in the circumstances that existed here for Mr. Lloyd to check up on the work of the bookkeepers to the extent that he would have discovered the error.
[61] Counsel argued that Mr. Lloyd was a businessman, worked hard at his business, worked many hours per week, took few vacations and was managing 30 to 40 people at the time that the error in question was committed. He looked after the affairs of about 11 companies. His work was done by others who he relied upon and whom he considered to be careful people. He had professional outside accountants working for him as well. Mr. Lloyd had people trained and/or experienced in accounting working for him as internal bookkeepers and bookkeeping assistants who worked with those internal bookkeepers to provide continuity.
[62] It was accepted that the error was committed by one of his staff and Mr. Lloyd accepted responsibility for it. However, Mr. Lloyd could not have done anything to avoid the error. He instructed the bookkeeper to make the entry and when he was advised that it had not been made, he instructed the bookkeeper again to make it. Finally, when the error was discovered by Ms. Hill, he once again instructed the entry to be made and consulted with Mr. MacKenzie, the accountant, as to how to report it. He reviewed each year's financial statements extensively with Mr. MacKenzie at the draft stage and this error would not have been obvious to either of them no matter how carefully they reviewed the financial statements.
[63] Even though the error was large when looked at in isolation, when looked at in context, the error was small in relation to the gross income of the company. Had the entry been properly made in the Appellant's book in 1988, it is the Revenue line on the Income Statement which would have been directly affected and would have increased just less than three percent. That differentiates this case from those referred to by the Counsel for the Respondent in support of her argument that where the amount of the discrepancies is large it should lead to a finding of gross negligence.
[64] In the case at bar the Appellant' director instructed the correct entry to be made and heard nothing back and assumed that it had been done properly. He honestly believed that it had been incorporated into the statements. In fact, he had to be convinced by Ms. Hill and Mr. MacKenzie that the entry had not been made. He did not direct the accountants to ignore it or hide it in any way.
[65] It was clear from the evidence that Mr. Lloyd had a very good idea what taxes should be payable after his annual discussion with his external accountant. Although he did not review the final tax return extensively, he knew the amount of tax that the Appellant would have to pay and he did not find in the year in question that the amount of taxes payable were significantly different from those that had been determined by Mr. MacKenzie before the final statements were prepared. There was no reason for him to go any further and inquire any deeper into the financial statements after his discussion with the external accountant.
[66] Counsel argued that the Minister has no right, taken lightly, under this section to open-up a taxation year where the right to assess has expired. (here it was 3 years) Otherwise, the Minister would be able to reassess at will no matter how minor the error and no matter how inadvertent the error. Surely this was not the legislature's intention. There must be a balancing under this section.
[67] A taxpayer may be careful without being perfect. Counsel for the Respondent is demanding that the Court apply the standard of perfection whereas what is required is a lower standard. That standard is that of carefulness.
[68] Here the Appellant was demonstratively careful and the evidence leads to that conclusion. Mr. Lloyd acted as a normally wise and cautious taxpayer would, yet, through no fault of his own and despite his best efforts, the error was made.
[69] Counsel submitted that the error was an innocent misrepresentation as contemplated in Halsbury's Laws of England (3rd Edition) vol. 26, pp. 844-8 and that no negligence was attributable to this error.
[70] On issue one, Counsel argues that the Minister should not be allowed to reassess after the normal reassessment period has expired. Further on the issue of penalties he submits that the Minister has failed to meet the burden of proof on this issue and has not established on a balance of probabilities that the Appellant made the misrepresentation "knowingly" or "in circumstances amounting to gross negligence" as set out in the cases referred to and that on this issue the penalty should be vacated.
Analysis and Decision
[71] In this case the Court is satisfied that there was a significant error made in the returns which were filed for the year in question. This error was not that of the accountant but was an error of the bookkeeping staff who were retained by Mr. Lloyd and upon whom he relied. In this particular case the error was not made only once but was repeated, in spite of the fact that Mr. Lloyd testified that he instructed the staff to make the necessary entries.
[72] Some question may be raised as to whether of not Mr. Lloyd actually remembered instructing that the entries be made and his evidence was that he was satisfied that he would have given those instructions based upon the document prepared by him that he reviewed after the fact. The Court will conclude as a fact in this case that Mr. Lloyd did give instructions for the amount to be entered into the books of the two companies and that these instructions were not followed through.
[73] However, that does not end the matter because it is obvious that Mr. Lloyd did nothing after that point in time to insure that his instructions were carried out. There could be no doubt from the evidence that there were a considerable number of problems existent in the bookkeeping aspects of the Appellant's business during the period in question. There were personal problems among some of the bookkeepers, Mr. Lloyd was not completely satisfied with the work, some of the employees were considered to be irresponsible. Any reasonable person in this position would have been put on guard that he would have to put in place, some form of verification for the work that the bookkeepers were doing.
[74] In spite of the evidence of the accountant that he did not instruct Mr. Lloyd to have reconciliations conducted as a matter of routine and in spite of the fact that he knew that there were active inter-company accounts during the year in question, one would have thought that unless there were some specific reasons for not doing so, in the circumstances that existed here it would be reasonable and prudent to recommend that such reconciliations be made.
[75] It is obvious that if reconciliations had been made of the inter-company accounts that this error would have been discovered. It was such a reconciliation that brought the error to the attention of a subsequent bookkeeper and her evidence was that it appeared to her for no particular reason except that the accounts did not look right. One would have thought that this same result would have appeared to one of the other bookkeepers, had they been as competent and careful as Mr. Lloyd indicated, to the accountant when he was doing the year end statements and preparing the income tax and to Mr. Lloyd in his day-to-day handling of the business affairs of this company.
[76] Mr. Lloyd pointed out that he was a "hands-on" type of person that had considerable experience in business, considerable experience in running a number of different companies, in managing a number of different people and he must have been aware of the fact that one cannot always rely upon someone else doing exactly what they are supposed to do. However, in the case at bar, in light of the problems that existed in this office it should have been clear to him that there were mistakes being made in the bookkeeping, that the bookkeeping staff were not doing what they were being paid to do and it would have been normal, cautious and prudent of him to have verified the work that they were doing during the year 1988 and he did not do so.
[77] The Court is satisfied that with the exercise of reasonable care or prudence during the year in question Mr. Lloyd would have been put on notice that something was wrong, that his instructions were not being carried out and the booking staff should have been checked.
[78] By and large, a review of the cases that have been referred indicate that in order for the Minister to rely upon the appropriate section to assess the taxpayers after the normal reassessment period has expired, the actions of the taxpayers must as of needs amount to negligence. Some of the cases seem to suggest that the word negligence is synonymous with the word careless or carelessness. At first blush one would think that the terms neglect and carelessness have a lower degree of severity than the word negligence but neither party has argued strenuously for that interpretation and appear to be content in arguing that this section requires that the actions of the taxpayers at least amount to negligence.
[79] The Court rejects the argument of Counsel for the Appellant that the actions of the taxpayer in this case amounted merely to an innocent misrepresentation or that the error was one which a normally wise and cautious taxpayer could have committed. Under the circumstances of this case the Court is satisfied that a normally wise and cautious taxpayer, much less a taxpayer with the knowledge, skill and experience in business that Mr. Lloyd possessed, would have discovered the error and should have discovered it.
[80] In this particular case the director of the Appellant indicated that he was a bit of "a cheap skate" when it came to the specifics of the accountant's engagement and that to some extent might have motivated the accountant not to suggest that the inter-company accounts should be reconciled regularly or at least at year end before the year end statements were completed and the income tax returns filed. It may very well be that both the accountant and Mr. Lloyd were satisfied that these bookkeeping functions would have been performed by the staff in place, but they were wrong and the staff committed an error which should have been picked up in time by a normally wise and cautious taxpayer.
[81] As Counsel for the Respondent correctly noted, during the year in question Mr. Lloyd decided on the lowest level of review. He hired people who did not necessarily have any bookkeeping experience and relied upon them to do what they were instructed to do. There was a pattern of mistakes in the bookkeeping of the company which should have been detected earlier. There was no follow-up by Mr. Lloyd to see if his instructions were carried out and he was well aware of the fact that there were a considerable number of personal problems in the bookkeeping staff which might have prevented them from doing their job adequately. He should have been put on guard that more follow-up and checking of the work was required.
[82] The Court is satisfied that the Minister is entitled to rely upon the provisions of subsection 152.4 and he was entitled to reassess the taxation year 1998 as he did. The Minister's assessment in that regard is confirmed.
[83] The Court turns now to consider as to whether or not the Minister was justified in levying penalties under subsection 163(2).
[84] Counsel for the Respondent acknowledged that the burden upon this issue was higher than the burden that she faced with respect to the first issue.
[85] As indicated in Venne (supra), at page 6256:
"Gross negligence" must be taken to involve greater neglect than simply a failure to use reasonable care. It must involve a high degree of negligence tantamount to intentional acting, an indifference as to whether the law is complied with or not."
[86] Further in Can-Am Realty Limited et al. (supra) at pages 6303 and 6304, the Court concluded that:
". . .What is required is conduct which is exceptional and flagrant to the degree of gross negligence. Although Mr. Podavin was remiss in his obligation to provide Mr. Chant with complete and exact information, I am not persuaded his conduct, with respect to that particular transaction in any event, amounts to gross negligence such as is necessary for the imposition of a penalty."
[87] Bowmen, J. in Farm Business Consultants Inc. v. The Queen 95 DTC 201 at pages 205 and 206 said:
"A court must be extremely cautious in sanctioning the imposition of penalties under subsection 163(2). Conduct that warrants reopening a statute-barred year does not automatically justify a penalty and the routine imposition of penalties by the Minister is to be discouraged. Conduct of the type contemplated in paragraph 152(4)(a)(i) may in some circumstances also be used as the basis of a penalty under subsection 163(2), which involves the penalizing of conduct that requires a higher degree of reprehensibility. In such a case a court must, even in applying a civil standard of proof, scrutinize the evidence with great care and look for a higher degree of probability than would be expected where allegations of a less serious nature are sought to be established. Moreover, where a penalty is imposed under subsection 163(2) although a civil standard of proof is required, if a taxpayer's conduct is consistent with two viable and reasonable hypotheses, one justifying the penalty and one not, the benefit of the doubt must be given to the taxpayer and the penalty must be deleted."
[88] On the basis of a reasonable consideration of the cases referred to and taking into account that the burden of proof is upon the Minister in this case, the Court is satisfied that the Minister has failed to establish that the conduct of the Appellant amounted to gross negligence which would entitled the Minister to impose penalties during the year in question.
[89] This finding is made in spite of the fact that the amount of the discrepancy was substantial. However, in this case such discrepancies do not lead the Court to conclude that the taxpayer could not have inadvertently failed to notice the discrepancy and the Court does not find that the size of the discrepancy was so large that it compels it to a finding of gross negligence.
[90] In the end result, the appeal will be allowed and the matter referred back to the Minister of National Revenue for reassessment and reconsideration upon the finding that the Minister was not entitled to levy the penalties and the penalties will be deleted.
[91] The Appellant will have 50% of its costs to be taxed.
Signed at Ottawa, Canada, this 16th day of November 1999.
"T.E. Margeson"
J.T.C.C.