Date: 20000913
Dockets: 1999-528-IT-G; 1999-46-IT-I
BETWEEN:
JOHN FRANKLIN, KYLE MacDONALD,
Appellants,
and
HER MAJESTY THE QUEEN,
Respondent,
Reasons for Judgment
Beaubier, J.T.C.C.
[1] These appeals were heard at London, Ontario on September 5, 2000. The Appellants are husband and wife. At the opening of the hearings the Court was advised by counsel for the parties that the appeal of Kyle MacDonald (1999-46(IT)I) is to be allowed by consent and that is so adjudged. Thereupon, the appeal of John Franklin proceeded pursuant to the General Procedure. John Franklin and his accountant, Peter Kennedy, C.A., testified as did the Respondent's auditor on the file, Brenda White, C.G.A.
[2] At the opening of Mr. Franklin's hearing counsel for both parties advised the Court that:
1. Respecting the 1993 assessment, it is agreed that Mr. Franklin is to be disallowed auto expenses he claimed of $6,656.36 and allowed the sum of $795.64.
2. Respecting the 1994 assessment, it is agreed that Mr. Franklin is to be disallowed auto expenses he claimed of $4,061.30 and allowed the sum of $2,108.70.
3. Penalties assessed against Mr. Franklin respecting these claims of expenses for 1993 and 1994 are to be recalculated accordingly.
Judgment is ordered accordingly on those terms.
[3] The Hearing proceeded respecting the only issue remaining between the parties. It is an assessment for benefits of $58,621.00 pursuant to subsection 15(1) of the Income Tax Act allegedly received by Mr. Franklin in 1992 from Homeguard Video Systems Ltd. ("HVSL") respecting an alleged sale of a ½ interest in a Florida condominium to Mr. Yates. The parties filed an Agreed Statement of Facts which reads:
AGREED STATEMENT OF FACTS
1. In March, 1991, Homeguard Video Systems Ltd. ("HVSL"), a company owned by the Appellant and his wife, purchased a condominium unit (the "Unit") in Florida. Title to the Unit was taken in the names of the Appellant and his wife to comply with the condominium corporation by-laws.
2. All monies required by HVSL to acquire the Unit were advanced by the Appellant out of his personal resources (including a personal line of credit extended to the Appellant by Canada Trust). All such advances were reflected (as a liability of HVSL as "due to shareholder") in HVSL's financial statements for its fiscal year ended March 31, 1992.
3. Shortly after acquiring the Unit, an undivided half interest therein was sold to a business acquaintance of the Appellant, who over the next two and one-half years paid the aggregate sum of Can.$59,423.50 (including interest) for such half interest.
4. Of the said aggregate sum of $59,423.50:
(a) $15,724.00 was deposited in a bank account maintained by HVSL;
(b) $21,299.50 was deposited in the Appellant's personal bank account; and
(c) $22,400.00 was applied on account of the Appellant's personal line of credit.
5. The said sale of an undivided half interest in the Unit was not recorded in the financial statements of HVSL, nor was the Appellant's shareholder's account reduced to reflect the receipt by the Appellant of a portion of the sale proceeds, until such error was disclosed by the Respondent's audit of the Appellant's and HVSL's tax returns.
[4] Paragraphs 6(a) to (m) inclusive of the assumptions in the Reply read:
6. In reassessing the Appellant, the Minister made the following assumptions of fact:
(a) the facts hereinbefore admitted;
(b) the Appellant and his spouse, Kyle MacDonald, are the only shareholders of HVSL;
(c) HVSL had two bank accounts and the Appellant had numerous personal bank accounts and a line of credit. All accounts (corporate and personal) were used interchangeably. Bank accounts were not reconciled and no system of internal control was in place;
(d) the Appellant is an astute businessman with a Master of Business Administration degree who took personal responsibility for maintaining the books and records of HVSL;
(e) the Appellant and HVSL kept no formal accounting and the records were so incomplete that many of the expense claims he had computed could not be reconciled;
(f) the records of HVSL contained numerous examples of expenses being claimed twice and sometimes thrice;
The Condominium in Florida
(g) on or about March 14, 1991, HVSL purchased a condominium commonly described as Unit 124, Vista Verde North, Pinellas County, Florida;
(h) the full cost of the purchase of the condominium was set up in the books and records of HVSL;
(i) on or about March 26, 1991 with a down payment of $10,480.25, Carl Yates of Sarnia purchased a 50% interest in the condominium in Florida from HVSL;
(j) except for the first two payments of $10,480.25 on March 26, 1991 and $1,000.00 on April 1, 1991, which were payable to HVSL, all payments from Mr. Yates were made by cheque and were made payable to John Franklin personally;
(k) the cheques received from Mr. Yates were deposited as follows:
|
HVSL Canada Trust account 101-507242 |
$15,724.00 |
|
John Franklin personal Canada Trust account 101-501859 |
21,299.50 |
|
Directly to John Franklin 'Powerline' line of credit (Canada Trust) |
22,400.00 |
|
$59,423.50 |
(l) the sale of the 50% interest in the condominium in Florida was not reported to HVSL's accountant by the Appellant and was not reflected in the books and records of HVSL. This resulted in the shareholder account credit balance being overstated by $58,621;
(m) by not debiting the shareholder loan account of the Appellant with the payments received by the Appellant from Carl Yates in respect of the sale of the 50% interest in the condominium in Florida, HVSL conferred benefits on the Appellant in his capacity as a shareholder of HVSL;
Paragraphs 6(a) to (k) inclusive were not refuted by the evidence but, to add to paragraph (g), the condominium purchase closed in HVSL's 1992 fiscal year. The first sentence of paragraph (l) is correct. The second sentence of paragraph (l) and paragraph (m) are the subjects in dispute.
[5] The parties agreed that the sale of the ½ interest to Yates occurred in 1992 for one-half the price at which HVSL purchased the condominium. The condominium was treated as a capital property of HVSL and was never depreciated. Therefore, the sale to Yates did not result in a gain or loss to HVSL. The only writing between Messrs. Yates and Franklin in evidence which confirms the condominium sale is a co-signed letter drawn by Mr. Yates dated August 20, 1993 (Exhibit R-3). The profits and losses of rentals of the condominium were reported by HVSL, but none were ever apportioned to Mr. Yates. In recent years, Mr. Yates has sold his ½ interest back to HVSL.
[6] Mr. Franklin never told Mr. Kennedy of the sale to Yates. Mr. Kennedy, as the accountant for HVSL and Mr. Franklin, was retained solely on a "compilation engagement". Mr. Franklin prepared rough handwritten sheets of incomings and outgoings and Mr. Kennedy reformatted them for financial statement and income tax purposes. If anything extra was required respecting the sheets, Mr. Franklin told Mr. Kennedy or, if Mr. Kennedy found a discrepancy, Mr. Kennedy inquired of Mr. Franklin. Thus, there is no error, negligence or inadvertent act by Mr. Kennedy which caused the failure to report which resulted in this assessment.
[7] Rather, the fault was solely Mr. Franklin's. Mr. Franklin appears to be in his 50's. His M.B.A. is from the University of Western Ontario and he is also a B.Eng. His business is to consult and advise other corporations on management relationships with banks. He denied having much accounting knowledge and Mr. Kennedy confirmed that denial. But the handwritten sheets which he prepared for Mr. Kennedy which are contained in Exhibit R-1 reflect an ability to distinguish income and capital, GST, interest, operating costs and fiscal years. To distinguish the sale to Yates only required determining what's mine and what's thine. But the sheets Mr. Franklin prepared didn't do this even though they itemized "Costs of Condo".
[8] Because there was no error by the accountant, Mr. Kennedy, the Court is of the view that the line of cases respecting subsection 15(1) of the Act arising from accountants' errors does not apply. The Court finds that Mr. Franklin deliberately failed to report the sale and the payments in dispute respecting the sale to Mr. Yates and in turn, to the Respondent. The amounts were large, they constituted a number of payments and at times unreported sums were paid periodically. Despite Mr. Franklin's protests of innocence or ignorance, he knew of these payments and what they constituted. He is also an experienced and, in some fields, expert businessman, who advises other businesses. While he reflected some confusion respecting a deposit recorded in HVSL's financial statement, the real confusion existed in Respondent's counsel and his questions. The Court finds that Mr. Franklin simply took the opportunity presented by Respondent counsel's confusion and went along with it. His answers did not reflect his understanding of the deposit amount; rather, they reflected Respondent counsel's misunderstanding. As a result of this finding, it remains for the Court to determine if, in fact, Mr. Franklin received a benefit from HVSL on account of the sums in question in 1992.
[9] Mr. Franklin testified that all money borrowed by HVSL was in fact borrowed by him through his "Powerline" account at Canada Trust because HVSL had no borrowing ability. This testimony is accepted as true. The Powerline account was secured by a mortgage on the Appellant's home. Money from the Powerline account was used as part of the purchase price of the condominium and money from the Powerline account was also used to purchase HVSL vehicles. Mr. Franklin deposited cheques from Mr. Yates made out to HVSL into its named account and cheques from Mr. Yates made out to him into his named accounts.
[10] Mrs. White testified that the assessment of a benefit of $59,412.50 for 1992 was because that is when one-half of the condominium was sold to Mr. Yates. That sale should have gone through HVSL's shareholder's loan account for Mr. Franklin so as to reduce the balance in his favour by that amount. When it didn't, Mr. Franklin was left with an apparent entitlement from HVSL that was $59,423.50 more than it should have been and therefore, Mr. Franklin had a benefit. In 1992 HVSL's balance sheet shows a loan from Mr. Franklin of $154,618 which would be $59,423.50 less if the Yates transaction had been properly recorded. The money HVSL owed to Mr. Franklin was unsecured, bore no interest and had no due date. If HVSL could not borrow, then money it owed to Mr. Franklin on its balance sheet could not be used by Mr. Franklin to secure a loan elsewhere because HVSL would not be recognized as a secure source of payment by a financial institution.
[11] Mrs. White stated that part of the reason for the assessment of benefit was the bookkeeping method adopted by Mr. Franklin and HVSL for HVSL. All of HVSL's receipts were treated as Mr. Franklin's and then accounted for in HVSL's name at its year end. The final adjustment occurred in Mr. Franklin's shareholder's loan. That is a correct description of the facts in this case. In her examination of Mr. Franklin's financial records, the money received from Mr. Yates by HVSL or Mr. Franklin was not immediately used to pay down the Powerline or to purchase assets from HVSL. However, the record shows that this did occur within a reasonably short interval. In fact, in one vehicle purchase, the vehicle was purchased several days earlier by Mr. Franklin and then the deposit of Mr. Yates' payment was used for the purpose of the purchase when it was received by Mr. Franklin.
[12] Mr. Franklin's shareholder's loan to HVSL remained $59,423.50 more than it should have been while he simply deposited the money in question to accounts which he had incurred in his own name for himself or for HVSL. That was set forth in HVSL's financial statements during all of the years subject to these assessments. This was known to Mr. Franklin and certainly ought to have been known to him in any event. Mr. Franklin did nothing to reverse this state of affairs and it was only when Revenue Canada's audit occurred that it was discovered by anyone else, namely, Mrs. White, the auditor. The entire set of occurrences was due to Mr. Franklin's actions, records and system of dealing with HVSL's activities in his own name.
[13] However, had the sale to Yates been properly recorded by HVSL, its assets would have fallen by one-half the value of the condominium as would the shareholder's loan to Mr. Franklin. Therefore, Mr. Franklin's total equity in his shares and his loan in HVSL would not have changed. Moreover, Mr. Franklin's correct net loan position in HVSL never fell into a deficit position during the years under appeal. As a result, what has occurred is a series of bookkeeping errors in HVSL's statements which were caused by Mr. Franklin either on purpose or inadvertently. But none of them gave him any benefit that is in evidence. He did not withdraw any money from HVSL in excess of his correct loan balance during the years in question. Nor is there any evidence that he used the incorrect financial statements to obtain a benefit elsewhere for himself. There was no receipt of a benefit by Mr. Franklin.
[14] For this reason the appeal is allowed and the Appellant is awarded party and party costs.
Signed at Ottawa, Canada this 13th day of September 2000.
"D.W. Beaubier"
J.T.C.C.