Date: 20000913
Docket: 98-2145-IT-G
BETWEEN:
GILLES BLAIN,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
(delivered orally from the bench on March 22, 2000,
at Montréal, Quebec, and revised)
Archambault, J.T.C.C.
[1] The Minister of National Revenue (Minister) issued reassessments in respect of the 1993 and 1994 taxation years. For 1993, the Minister added an amount of $5,330 as salary income to Mr. Blain's income. For 1994, the Minister added $47,728 representing the value of assets that Mr. Blain had allegedly appropriated. Those assets belonged to Ballon Beko Ltée (BBL), a company in which Mr. Blain held 72% of the shares. The Minister also assessed penalties under subsection 163(2) in respect of the two taxation years in question. Mr. Blain's appeal concerns only the 1994 taxation year.
[2] At the start of the hearing, Mr. Blain admitted the facts in subparagraphs 4 (a), (b), (c) and (d) of the Reply to the Notice of Appeal.
Factual background
[3] Mr. Blain holds a bachelor's degree in administration. Incorporated in 1985, BBL operates a business that sells latex balloons on which it generally places printing of some description.
[4] BBL owns equipment that it purchased from foreign manufacturers and had to upgrade to meet its own needs and quality standards. Mr. Blain stated moreover that he spent a great deal of time improving the performance of that equipment. BBL employs a dozen workers—about eight of whom are full-time employees, including its two shareholders—and a secretary. On occasion, extra staff has to be hired.
[5] Mr. Blain's joint shareholder primarily handles the production, staff and orders for raw materials; Mr. Blain takes care of sales, marketing, banking, purchasing equipment and negotiations with suppliers regarding the price of the raw materials.
[6] The secretary handles the bookkeeping, and an outside accountant, a CGA, prepares the financial statements, including the year-end adjusting entries. BBL's fiscal year ends on March 31. The CGA also prepares the company's income tax returns. BBL's sales figure rose from $35,000 in 1985 to approximately $855,900 in 1993.
[7] After filing its tax return for the 1994 taxation year, dated October 10, 1994, BBL filed amended financial statements dated August 12, 1995, in order to claim an additional reserve of $64,845 for a bad debt.
[8] In November 1995, the Minister's auditor began working on the BBL file. In the course of his audit, he noted that the corporation had claimed capital cost allowance on equipment, some of which had allegedly been purchased in 1994. According to the statement of changes in financial position as at March 31, 1994, which was part of the financial statements of August 12, 1995, BBL purchased $82,987 worth of fixed assets in 1994. That amount was shown on Form T2S(8) filed with the original tax return of October 10, 1994 for the 1994 taxation year.
[9] As supporting documentation with respect to part of that equipment (fictitious equipment), the company's representative provided three invoices, each for approximately $22,097 ($66,289.71 in total), which Mr. Blain acknowledged in his admissions were false invoices.
[10] The $66,289.71 amount also appears in BBL's accounting records as an adjusting entry, as follows: [TRANSLATION] "Entry 204 re: invoice 11161-62-63: 1610 equipment $66,289.71 to debit, 4011 sale of product, $66,289.71 to credit."
[11] During the audit, the auditor noted that the three invoices referred to above were each copies of the same document, bearing the same date and same fax transmission time, the only difference being the number on each. The first copy is numbered 11161, the second, 11162, and the third, 11163. Moreover, an examination of the copies of the invoices shows that the figures "2" and "3" in these numbers have been carefully altered by hand. If they are not examined with care, one might not realize that the figures are handwritten.
[12] The auditor went to see the supplier, who confirmed that these invoices were only purchase orders and not invoices for goods and services delivered. There was therefore no sale of equipment to BBL by that supplier. The auditor also noted that there was a purchase order bearing number 11163, but it had been sent to one of the supplier's other clients.
[13] As he had been informed by Mr. Blain that the purchase of the equipment from this supplier had been financed in part by a $55,000 loan advanced by the Federal Business Development Bank, the auditor went to that bank to verify Mr. Blain's statements. He learned then that the funds in question had been used to refinance other machinery than that covered by the three false invoices.
[14] Having noted that the invoices were false, the auditor concluded that the $66,289.71 in sales revenue had been appropriated by BBL's two shareholders and, in a letter dated February 18, 1997, he informed Mr. Blain that he planned to include in his income his share (72%) of that revenue, that is, $47,728, as an appropriation of funds.
[15] The Minister's auditor stated that he had given the draft assessment to Mr. Blain on February 25, 1997, and explained to him that he had until March 18, 1997, to provide his comments. It should be added that the draft assessment also applied to the 1993 taxation year and that the auditor intended to increase Mr. Blain's income by adding unreported salary income of $5,330. A similar draft assessment was also given to Mr. Blain's joint shareholder.
[16] The auditor also gave Mr. Blain a draft assessment for BBL in which he informed Mr. Blain of his intention to add to that company's income an amount equivalent to the capital cost allowance claimed by BBL for the fictional equipment. The $66,289.71 in revenue shown in entry number 204 was thus not subtracted from the income reported by BBL. For the 1993 taxation year, the auditor also disallowed an amount of $39,175 as an expense for the purchase of goods for which BBL did not provide supporting documentation, which amount appears in the accounting records as an adjusting entry. This time, the entry corresponding to the purchase was posted to the [TRANSLATION] "owed to directors" account.
[17] At the meeting of March 18, 1997, Mr. Blain and his accountant told the auditor that Mr. Blain accepted all the changes except those resulting from the three false invoices. A few days later, new amended financial statements for the 1994 taxation year, dated April 4, 1997, were filed with the Minister. The amount appearing under the [TRANSLATION] "owed to shareholders" balance sheet item was reduced by $39,175 to reflect the fact that the auditor had disallowed an equivalent amount for the purchase of goods and that BBL accepted that change. However, the income statement showed no reduction of revenue by $66,289.71.
[18] In his testimony, Mr. Blain categorically denied that BBL had paid the $66,289.71 to him and his joint shareholder. He said that his company did not have the means to do so and to have done it would have caused it irreparable harm. In addition, he maintained that, if the adjusting entry showing the purchase of fictional equipment at a cost of $66,289.71 were cancelled, the inclusion of an equivalent amount in the company's sales would also have to be cancelled. According to him, it made no sense to cancel only half of the adjusting entry.
[19] Mr. Blain also said he did not know who could have given the false invoices to the accountant, but acknowledged that it might have been him. Asked [TRANSLATION] "Who would have altered them and why would that person have done so?" he answered that it was his accountant who had made the accounting entries. When I asked him why the accountant would have done that, he offered this explanation: he (Mr. Blain) had complained on several occasions that BBL's equipment was undervalued; he had had to spend a great deal of time on upgrading the performance of that equipment; and BBL should receive research and development credits.
[20] According to Mr. Blain, BBL ceased operations in 1998, after which BBL's banker called its line of credit in February 1998.
Analysis
[21] First, it is important to remember that the onus was on Mr. Blain to show that the inclusion of the appropriated funds for the 1994 taxation year is wrong. However, it was the respondent who had the burden of establishing that Mr. Blain knowingly, or in circumstances amounting to gross negligence, made a false statement in his income tax return.
Appropriation of $47,728
[22] I will first deal with the issue of the appropriation. On the one hand, Mr. Blain categorically denied receiving $47,728 from BBL because that company could not afford to pay it. I note that there was no corroborating evidence regarding BBL's difficult financial situation.
[23] I note, however, that Mr. Blain, in his testimony, made reference to the fact that BBL had claimed a reserve for a bad debt of $64,845. It was because of BBL's bad financial situation and a bad investment made by BBL in another company that the reserve was deducted. That reserve for a bad debt was disallowed by the auditor and it would seem, according to the auditor's testimony, that BBL accepted the disallowance. Confirmation of the acceptance was apparently given at the meeting of March 18, 1997.
[24] On the other hand, Mr. Blain took great offence at the doubt cast by counsel for the respondent on his credibility. I am not in a position to state that Mr. Blain is a barefaced liar or has no credibility. However, the evidence clearly shows that Mr. Blain could make mistakes in telling his version of the facts.
[25] Here are a few examples of instances where he is clearly mistaken. Mr. Blain says he filed his amended financial statements of April 4, 1997, before he learned that the auditor had discovered the three false invoices. In the course of argument, I pointed out to Mr. Blain that, according to the auditor's reply to one of his questions, the draft assessment had been completed on February 18, 1997. Since Mr. Blain said that it was possible that the draft was not sent to him until after April 4, 1997, I then decided to reopen the evidence to question the auditor further on the circumstances surrounding the sending of the draft assessment.
[26] The new testimony revealed that the draft assessment had indeed been completed on February 18, 1997, that it had been given to Mr. Blain on February 24, 1997, and that it was on March 18, 1997, at a meeting, that Mr. Blain and his accountant had provided their comments to the auditor.
[27] Thus, the evidence clearly reveals that, contrary to Mr. Blain's assertions, when he filed his financial statements of April 4, 1997, he knew very well that the Minister had discovered the false invoices and that he was disallowing the inclusion of an amount of $66,289.71 for fixed assets, and that he was keeping an equivalent amount in BBL's income.
[28] Mr. Blain's income tax returns for the 1993 and 1994 taxation years indicate that he earned no income during those two years. Questioned on his source of funds for meeting his personal needs, Mr. Blain said he used money paid to him by BBL and that the amounts in question may have been repayment of advances he had made to the company. Yet, an examination of the financial statements for 1993 and 1994 reveals that not only did the balance of the "owed to shareholders" account not decrease, but, on the contrary, it increased by an amount of approximately $6,000. It was instead the shareholders who increased their advances to the company. That is a situation which consequently casts serious doubt on Mr. Blain's version.
[29] I also note that Mr. Blain informed the auditor that the purchase of the fictional equipment had been financed by the Federal Business Development Bank whereas the evidence shows that the funds obtained from that bank were used instead to refinance other machinery. It is important to remember here that it was Mr. Blain, and not his joint shareholder, who, generally speaking, negotiated with the bankers and handled equipment purchasing. It is therefore rather surprising to note that Mr. Blain was mistaken when he told the auditor about the source of the financing for the purchase of the fictional equipment.
[30] I also note that Mr. Blain is not above cheating. When he explained the circumstances surrounding BBL's deduction of a reserve for a bad debt, he told the Court that BBL's investment in another company had been uncollectable for two years and that he had waited for two years to deduct the reserve because he did not want to alert his banker to BBL's true financial situation.
[31] It must also be noted that, although Mr. Blain declared no income for 1993, he accepted the Minister's addition to his income of $5,330 in salary. That amount was unreported income in respect of which the Minister assessed a penalty under subsection 163(2). I would point out here that the taxpayer does not object to the assessment for the 1993 taxation year. It is quite understandable that a taxpayer might forget to declare an amount of $5,000 if he is earning $100,000, but to forget $5,000 when one is declaring no income at all is rather surprising.
[32] Although it cannot be established with certainty that the answers given by Mr. Blain are manifestly wrong, I find some of the answers provided by him in his testimony implausible. It must be remembered that it was Mr. Blain who signed BBL's tax returns. He said he signed them without examining them carefully and without looking at the financial statements, and yet he held a bachelor's degree in administration and was the one who handled negotiations with the banker. He stated that he did not notice in Form T2S(8) attached to the tax return for 1994 that the amount of purchases was $82,987 in 1994. He made the same assertion about the same amount, described as relating to the purchase of fixed assets, that appeared in the amended financial statements dated August 11, 1995, and that were filed with the Minister before the audit began in November 1995. The acquisition cost of the fictional equipment represented approximately 80% of all those purchases! In note 4 of the financial statements filed with the original tax return, the fixed asset amount under the equipment item is $202,771 and the net value goes from $78,083 in 1993 to $133,764 in 1994, an increase of 71.3% of the book value (($133,764 - $78,083) ÷ $78,083). I find it rather surprising that Mr. Blain did not note such an increase. It was, after all, the same Mr. Blain who said he had complained in the past that BBL's equipment was undervalued and who claimed he had pressured his accountant in that regard.
[33] In addition to this evidence, which inclines me to believe that Mr. Blain's version of the facts is not credible, there are other indicia that militate against Mr. Blain's position. Chief among them is the fabrication of false invoices. I believe that the evidence in that respect is very clear; it was a deliberate act by someone: the three invoices that were provided to the Minister are copies of the same sales order; the time and date of transmission are the same for all three. The fact that someone altered the invoice numbers by hand clearly indicates that the false invoices were deliberately fabricated. On a balance of probabilities, Mr. Blain at the very least knew that these invoices had been falsified.
[34] It cannot be concluded here that it was, as Mr. Blain claims, a simple accounting error. There is no evidence that it was BBL's accountant who fabricated the false invoices. It would be rather surprising in any event that a professional, a member of a professional body, would be a party to such skullduggery. It is not impossible that he was: there are of course undesirables in all human groupings. But the accountant did not testify at the hearing to explain his version of the facts.
[35] I would point out that in Enns v. The Minister of National Revenue, APP-1992(IT), at page 3, Judge Sarchuk of this Court cited a passage from Sopinka and Lederman, The Law of Evidence in Civil Cases, in which the authors comment that the failure to call a witness may be considered as a circumstance unfavourable to an appellant's position. The relevant passage reads as follows:
The application of this maxim has led to a well-recognized rule that the failure of a party or a witness to give evidence, which it was in the power of the party or witness to give and by which the facts might have been elucidated, justifies the court in drawing the inference that the evidence of the party or witness would have been unfavourable to the party to whom the failure was attributed.
[36] It is important to note here that, in his testimony, Mr. Blain stated that his accountant was not in good health and could not come and testify. However, I also note that no doctor's note was produced to confirm the accountant's state of health.
[37] What could have been said to explain the fact that someone fabricated the three invoices in question and that equipment that had not really been purchased by BBL was capitalized? The main explanation put forward by Mr. Blain was that he found that his equipment was undervalued on the balance sheet and had told his accountant so. He thought it was unfair that BBL could not receive tax credits for research and development; according to him, that could explain why his accountant would have made the adjusting entries referred to above.
[38] Is it possible that the purpose of thus increasing the company's assets was to show its financial situation in a more favourable light? I should note that the above explanation was not offered with any great conviction by Mr. Blain when he testified. He mainly emphasized the undervaluation of his equipment for the purposes of research and development tax credits.
[39] I should also mention that BBL did not see fit to object to the Minister's decision disallowing the deduction for the reserve for a bad debt. The evidence is not sufficient to establish accurately and with certainty the company's true financial situation at that time. For the two financial years 1993 and 1994, BBL initially filed financial statements showing profits for those two years. For 1993, the amount of net profit before tax was $18,330 and, for 1994, $13,855.
[40] In support of his argument that he had not received the $47,728 that the Department had characterized as an appropriation in assessing him, Mr. Blain asked why he would have appropriated that amount when his share of the amounts owed the directors was $84,270.24. As counsel for the respondent pointed out, the fact that Mr. Blain did not use the mechanism of reimbursement of his advances as a means of being paid the amounts in question allowed him to receive the payments without any tax consequences for subsequent taxation years.
[41] I also note that there was no evidence that the amounts owed to the two shareholders were divided up in proportion to their share in the capital stock of BBL and there was no evidence establishing the amount of Mr. Blain's advances to BBL. I find it rather surprising that Mr. Blain does not remember to which shareholder BBL owed the $14,284[1] appearing in the "owed to shareholders" account. That amount represented the balance of a $15,000 amount indicated in note 5 of the financial statements of August 12, 1995.[2]
[42] Another possible argument in support of Mr. Blain's position is the fact that it would be rather surprising that a taxpayer like BBL would have reported additional income of $66,289.71 if the intention was for the shareholders to appropriate the money without declaring it as income in their own tax returns. Often, in such circumstances, the taxpayers hide the income. It is important to note that, without the inclusion in BBL's income of the $66,289.71, that company would have recorded a loss. Indeed, even after including it, BBL only declared net income of $12,401. Of the $66,289 declared by BBL, only 18.7% ($12,401 ÷ $66,289) was actually subject to tax. Moreover, by increasing its fixed assets by $66,289.71, BBL could obtain, not just for 1994 but also for subsequent years, a reduction in income through capital cost allowance. The rate of depreciation for the equipment in question was 20%. Therefore, the scheme used by BBL to artificially increase its assets allowed it to absorb the additional income that it might have been tempted not to report.
[43] There are also other facts that, in themselves, would not be a sufficient basis for concluding that Mr. Blain appropriated the $47,728; however, those circumstances, added to the ones I have already described, comfort me in my conclusion in this appeal.
[44] First of all, Mr. Blain maintains that the $66,289 should be deducted from BBL's income because it is the second part of an adjusting entry that, according to him, the accountant made in error. If that argument were to be accepted, the gross revenue of the company for 1994 would fall to $756,119, which would represent an approximately 12% decrease by comparison with the revenue reported for 1993.
[45] In addition, if Mr. Blain and BBL strongly believed that the Minister should have decreased BBL's income by $66,289, why did BBL, in its amended financial statements of April 4, 1997, not decrease its income by that amount? As we saw earlier, it is clear that those financial statements were filed after BBL and Mr. Blain were told that the amount appearing as the cost of the fictional equipment had to be excluded.
[46] On the whole of the evidence and on a balance of probabilities, I find that Mr. Blain appropriated $47,728 in the 1994 taxation year and that that amount must be included in his income under subsection 15(1) of the Income Tax Act as a benefit conferred by BBL on Mr. Blain as a shareholder.
Penalty
[47] Having reached that conclusion, it remains for me to deal with the question of the penalty. As counsel for the respondent argued, if I found on a balance of probabilities that Mr. Blain had appropriated $47,728, it would be relatively easier to find that he had knowingly, or in circumstances amounting to gross negligence, made a false statement in his tax returns. It seems to me that it is reasonable to believe that Mr. Blain knew of the existence of the false invoices and that they were a device to allow him to appropriate assets belonging to BBL.
[48] It is important to remember that Mr. Blain holds a bachelor's degree in administration and that he had been managing a business since 1985. It may be inferred from this that he is a taxpayer who is well aware of his tax obligations. Failure to report income actually received of $47,728 in a case where the return that was filed showed no income is the conduct of a person who knowingly or, at the very least, in circumstances amounting to gross negligence, made a false statement in his return. I find therefore that the respondent met the onus that was on her.
[49] For these reasons, Mr. Blain's appeal is dismissed with costs.
Signed at Ottawa, Canada, this 13th day of September 2000.
|
"Pierre Archambault" |
J.T.C.C
Translation certified true
on this 23rd day of November 2001.
Erich Klein, Revisor
[OFFICIAL ENGLISH TRANSLATION]
98-2145(IT)G
BETWEEN:
GILLES BLAIN,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeal heard on March 21, 2000, and judgment delivered orally
on March 22, 2000, at Montréal, Quebec, by
the Honourable Judge Pierre Archambault
Appearances
For the Appellant: The Appellant himself
Counsel for the Respondent: Michel Lamarre
JUDGMENT
The appeal from the assessment made under the Income Tax Act for the 1994 taxation year is dismissed, the whole with costs.
Signed at Ottawa, Canada, this 11th day of April 2000.
"Pierre Archambault"
J.T.C.C.
Translation certified true
on this 23rd day of November 2001.
Erich Klein, Revisor
[OFFICIAL ENGLISH TRANSLATION]