Date: 20010821
Docket: 98-1745-IT-G
BETWEEN:
GLENN McCARTHY,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
_______________________________________________________
Counsel for the Appellant: D. Andrew Rouse
Counsel for the Respondent: Marcel Prevost
_______________________________________________________
Reasons for Judgment
(Delivered orally from the Bench at Fredericton, New Brunswick, on July 13, 2001)
Bowie J.
[1] Mr. McCarthy appeals from assessments for income tax for the 1992, 1993 and 1994 taxation years. The assessments were done by the net worth method, and they increased his income in 1992 by $100,027, in 1993 by $33,818 and in 1994 by $40,086.
[2] Net worth assessments are made by the Minister of National Revenue (the Minister) either because the taxpayer has not maintained books and records that will permit an assessment of his income to be made by ordinary methods of accounting, or where the books and records kept by the taxpayer are thought not to be reliable. A net worth assessment has been called a crude assessing tool, and so it is. However, there are situations in which the Minister has no reasonable alternative but to resort to it. That this is one such occasion is not disputed by Mr. Rouse, counsel for the taxpayer.
[3] In simple terms, the net worth approach to estimating income consists of establishing a personal balance sheet for the taxpayer. The Minister, so far as he can, computes the assets and the liabilities of the taxpayer at the beginning of the year being assessed and at the end of it. He also estimates the living expenses of the taxpayer for the year. Those living expenses, plus any increase or minus any decrease in net worth during the year, is then assumed to be the taxpayer's income for the year, subject to any other explanation that the taxpayer may have of the change in net worth, such as the receipt of an inheritance, or a run of good luck at the casino. As with all assessments of tax, once it has been made it is for the taxpayer to show by his evidence that it is wrong. Net worth assessments usually include many variables, any or all of which may be the subject of attack by the taxpayer. In the present case, Mr. Rouse has not taken the approach, often favoured, of attacking many of the elements of the assessment with a view to raising doubt where he may. Instead, he has chosen to attack four discrete elements of the net worth calculations. Before I turn to those, however, I should say a few words about the Appellant.
[4] Glenn McCarthy grew up in the Miramichi region of New Brunswick, in or around Blackville. At some point he moved to Ontario to work and live. There he seems to have prospered, at least in part, through the considerable inflation of real estate values which took place in the 1970s and 1980s. When he retired and returned to the Blackville area, it was with a considerable amount of liquid cash to invest. Most unfortunately, between the years under appeal and the present time, he suffered a very serious injury in a motor vehicle accident. He was unconscious for some six months, and when he recovered it was with some residual brain damage which has caused significant loss of memory. Consequently, his recollection of events which took place in and around the years under appeal is incomplete. He frequently said in his evidence that he does not recall information that under other circumstances he would have been expected to remember. I do not have the impression that he did so to be evasive; for the most part, I believe that he tried to answer the questions he was asked fully and truthfully. Unfortunately, he was not always able to do so. Nevertheless, the burden of proof is his to discharge as best he can.
[5] I return now to deal with the objections which the Appellant has raised to the assessments under appeal. When the Appellant returned to Blackville, shortly before the years under appeal, he started a business called the Blackville Diner and Take-Out Incorporated. I shall call the corporation "the Diner". It operated a diner, as the name suggests, in the Village of Blackville. Mr. McCarthy was the only shareholder, officer and director of the corporation. Blackville is a small community, and the Diner was a small operation, run by Mr. McCarthy and one or two other people at any given time. Its premises at first were old and inadequate, and Mr. McCarthy spent a good deal of money in the period between July 1991 and July 1992 to improve them; somewhere between $32,000 and $35,000. He also built a garage in the summer of 1994. The Diner was not a profitable venture. According to the financial statements in evidence, it reported the following losses: in 1991, $16,775; in 1992, $29,841; in 1993, $12,729; in 1994, $15,714.
[6] Once a net worth is established for the beginning of a period being assessed, any increase in the assets of the taxpayer during that period has the effect of increasing the estimate of the taxpayer's income for the period, unless it is accompanied by an offsetting liability. The bookkeeper who prepared the annual financial statements for the Diner operated on the assumption that the loss for each year must have been supported by equal contributions of cash to the business in the form of loans from Mr. McCarthy. Consequently, each year the company's balance sheet shows a loan balance owing to Mr. McCarthy which is greater than the previous year end loan balance by the amount of the loss recorded for the year just ended. This, of course, is a crude method of accounting, but with the records available to him it is no doubt the best that he could do, and neither party disputed the use of this methodology in arriving at the balance of Mr. McCarthy's shareholder loan account at the end of each of the relevant years. However, the Appellant does dispute the quantum of the losses said to have been suffered by the Diner in each of the years under appeal. He says that they are too high. If he is correct, then the amount added to his loan account is also too great, and the effect is to overestimate his net worth at the end of the year to that same extent.
[7] The Respondent, while not disputing that to overstate the loss would have that effect, says that the losses are in fact not overstated, and that the assessor was entitled to rely as he did on the financial statements of the Diner for each of the relevant years. The major issue in dispute then, is whether or not those losses are overstated, and if so by how much. I shall return to that issue shortly. First, I will deal with the other three issues that Mr. Rouse has raised.
The truck
[8] The first of these is the truck. The assessor learned that Mr. McCarthy had acquired a new 1992 model truck. He included it in Mr. McCarthy's assets for the first time in the year 1992. In fact, Mr. McCarthy acquired the truck in late December 1991, and so it should have been included in his December 31, 1991 net worth. Mr. McCarthy's evidence as to this is corroborated by insurance records. Mr. Prevost, for the Crown, quite properly conceded this issue at the trial, after the evidence established the fact that the truck was acquired in 1991 and not 1992. Sixteen thousand dollars is the value of the truck, and this amount is to be deleted from the estimate of income for the 1992 year.
The garage
[9] The assessor mistakenly believed that the garage was built in 1993. He estimated its value at $15,000, and he included that amount in Mr. McCarthy's net worth at December 31, 1993. He said in his evidence that he expected Mr. McCarthy to dispute the $15,000 value, and that he would then have attempted to negotiate an agreed-upon value. In fact, the garage was built in 1994, as the numerous receipts for materials prove. Mr. Derek Williston, an experienced carpenter, gave the opinion in evidence that the materials at that time would have cost about $4,500. He did not pretend to fix the figure precisely, because prices do vary, and estimates are only that. For example, the range of prices for garage doors is considerable, depending on the quality. The one actually bought and installed cost somewhat more than Mr. Williston had allowed. I think that $5,000 is a likely amount for the materials that went into the construction of the garage. The labour was contributed by a Mr. McCormack. Mr. McCormack was not paid for his labour, he said, because he had an arrangement with Mr. McCarthy that he would be able to use the garage to run a small engine repair business after it was built. In fact, that business never came into existence, and Mr. McCormack did not get any benefit from his labour. Despite a vigorous cross-examination, I accept his evidence that he was not paid. The garage should not have been included in Mr. McCarthy's assets in 1993 at a cost of $15,000. It should have been added in 1994 at a cost of $5,000. The $15,000 should be deleted from the 1993 taxation year. I shall return to the question of whether the $5,000 should be added to 1994.
Renovations
[10] The next item is the Diner renovations. When the renovations were carried out on the Diner premises, the bookkeeper, for reasons which the evidence does not reveal, accounted for them by adding $35,000, or more precisely $34,999.91, to the value of buildings shown on the balance sheet, and at the same time he added an equal amount to Mr. McCarthy's shareholder loan account, no doubt on the theory that Mr. McCarthy personally must have been the source of the funds to pay for the work and materials. In fact, much of the spending was done in 1991, not 1992, and the increase to Mr. McCarthy's loan account should have reflected this. Vouchers totalling some $32,264 were produced at trial; of these, $24,401 were for amounts spent in 1991 and $7,863 were for amounts spent in 1992.
[11] The Appellant's record-keeping is such that I can have no confidence that he was able to produce all the invoices for all the work and materials. The bookkeeper's number of $34,999.91 is likely more accurate. However, I agree with Mr. Rouse that the amount spent in 1991 should have been added to the loan account in 1991, and the amount spent in 1992 should have been added to it in that year. Mr. McCarthy's entitlement to be repaid logically dates from the time at which he made the outlay. His December 31, 1991 loan account balance should therefore reflect the $24,401 which he has shown was expended in 1991. This has the effect of reducing the estimate of his income for 1992 by that amount.
Overstated Losses
[12] I come now to the overstated losses of the Diner, which is the most unusual aspect of the appeals. The Appellant's contention is that the losses of the Diner were overstated in each of the 1992, 1993 and 1994 years, with the result that the increases to his shareholder loan balance were also overstated, causing the estimate of his net worth and, therefore, the estimate of his income for each of the years, to be overstated as well. This contention is based upon evidence that Mr. McCarthy, as the manager of the Diner, engaged in a practice of creating false entries in the payroll records of the Diner. These false records show wages to have been paid to a number of persons which were never paid at all. They recorded expenses never incurred, and so resulted in an inflation of the loss for each year. If the only evidence of this practice came from the Appellant himself, I would be inclined to disbelieve it. That was not the case, however. Four individuals gave evidence to the effect that they had been on the Diner payroll for periods in excess of the time that they actually worked there, or, in two of the cases, that they never worked there at all.
[13] Jackie Curtis said that she worked at the Diner for one week in 1992, for which she received no pay whatsoever. She did, however, receive a Record of Employment showing that she had worked there for several weeks, and she received a T4 slip for that year showing earnings of $3,009. She used the Record of Employment to apply for and receive unemployment insurance benefits. The payroll ledger shows her as having been paid a gross amount of $3,009.
[14] Roberta Duffy also received a Record of Employment showing that she had worked at the Diner in 1992. However, her evidence was that she did not work there at all. She received a T4 slip showing gross earnings of $4,150 for the year, and that amount was recorded in the payroll ledger. She testified that her father and Mr. McCarthy were friends, and that her father had arranged with Mr. McCarthy that this false Record of Employment would be given to her for her benefit. She believed that her father had paid Mr. McCarthy some money as part of this arrangement, but she could not say how much.
[15] Velma Campbell gave similar evidence. In 1994, she worked for four, five or six weeks at the Diner -- she was uncertain which. She said that she was not paid at all, because Mr. McCarthy told her that he was not making enough money to be able to pay her. He could, however, give her a false Record of Employment if she would work without pay, and that is what in fact happened. She was given a T4 slip showing earnings of $2,013 for the year, which she never received. She, too, used the Record of Employment to apply for and receive unemployment insurance benefits. She said that she had paid Mr. McCarthy, whom she had known for many years, something in return for doing this, but she also could not be sure how much.
[16] Jo-Anne Burns said that she worked at the Diner in 1992, 1993 and 1994, but received no pay for doing so. She did, however, receive a false Record of Employment, and she too received unemployment insurance benefits on the strength of it. Her T4 slips for the three years showed gross earnings of $7,516, $7,754 and $10,113 for these three years, and these same amounts appear as her gross pay in the payroll records. Jo-Anne Burns also arranged a similar transaction with Mr. McCarthy for her mother, Doreen Burns. Doreen Burns did not work at the Diner at all, but in 1994 she too was given a false Record of Employment which she used to obtain benefits, and she was given a T4 slip showing earnings of $4,589. That amount was charged as her gross pay in the payroll ledger.
[17] Mr. Prevost cross-examined all of these witnesses thoroughly, but did not shake their evidence. They all knew that they were committing an offence when they claimed unemployment insurance benefits on the basis of false Records of Employment. They knew that it was an offence, as well, to file false income tax returns. Mr. Prevost argued that their evidence was not credible, and he asked me to dispose of this aspect of the case on that basis.
[18] I observed all of these four witnesses carefully. I think it is most unlikely that any of them would commit perjury, and admit under oath to committing serious offences, if they had not, in fact, done so. It is not logical that they would give that evidence simply to assist Mr. McCarthy in his income tax appeals. All of these witnesses appeared to me to be telling the truth to the best of their recollection. I accept their evidence that they did not receive the pay that was recorded as having been paid to them. I believe that the attitude of Mr. McCarthy and of these four witnesses was, as Ms. Burns put it in her evidence, "... that's what friends are for...". Perhaps Mr. McCarthy felt that he was enhancing his standing in the community by conferring benefits on people to which they were not entitled. In any event, I accept that the payroll entries for these five people were falsified, and the effect was to overstate the losses of the Diner for the years in question. I reach that conclusion on the basis of my observation of the demeanour of each of Ms. Curtis, Ms. Duffy, Ms. Campbell and Ms. Burns, and also because their evidence is a more probable scenario than the alternative, which is that they were committing perjury to assist Mr. McCarthy.
[19] I do not, however, accept Mr. McCarthy's evidence that he too did not receive certain pay recorded in the Diner's payroll ledger as having been paid to him. I have referred already to his memory loss. It is illogical that he would have created a false payroll record for himself. He would not have been in a position to benefit, personally, from doing that. He also had considerable to gain by giving this evidence, as it would be to his benefit in this appeal.
[20] There was some evidence that amounts were paid to Mr. McCarthy by the employees who gave evidence, or in the case of Ms. Duffy, by her father, and also by Doreen Burns. However, this evidence from each of the witnesses was so vague as to be worthless. I conclude on the balance of probability that of the amounts charged as a payroll expense in the case of each of the five employees in question, it was only the net pay shown in column 10 of the payroll ledger sheets that was not, in fact, paid. I believe the evidence to the effect that the various amounts for the Canada Pension Plan contributions, unemployment insurance premiums and withholding of income tax were, in fact, remitted. Had they not been, the whole scheme would have been quickly detected.
[21] It may seem counter-intuitive that the Appellant can achieve a degree of success in this appeal by leading evidence of his own fraud. No authority dealing with that issue has been cited to me, and I am not aware of any. This is not a case where the issue is whether the proceeds of fraud are taxable. In my view, in the case of a net worth assessment, the estimates of income must stand or fall on the basis of the facts as they are actually proven to have existed in the years under appeal. Here the expenses were, in fact, overstated by the amounts that were entered in the payroll ledger and not paid. The bookkeeper's entries have had the effect of causing those amounts to be added to the income assessed to Mr. McCarthy. If the assessor had had the correct information, the assessments would have been for lesser amounts, and they should now be adjusted accordingly.
[22] The amounts overstated in the payroll ledger for the three years in question are the following: In 1992: for Ms. Curtis, $2,312; for Ms. Duffy, $3,185; for Jo-Anne Burns, $4,520; a total of $10,017, which I shall round to $10,000. In 1993: for Jo-Anne Burns, $3,948, and that is the total for that year. In 1994: for Jo-Anne Burns, $4,841; for Doreen Burns $2,600; for Velma Campbell $2,784; a total of $10,225. The result, then, for the three years in question is the following: For the year 1992, there should be deducted from income by reason of the truck issue, $16,000; by reason of the overstated loan account balance arising out of the renovations, $24,401; by reason of the overstatement of wages, $10,000; a total of $50,401 to be deleted from the income for the year 1992. For the 1993 taxation year, the overstated value of the garage of $15,000 is to be deducted; the overstated wage expense, $3,948 is to be deducted. The total reduction of the 1993 income is $18,948. For the 1994 year, the overstated wage expense is $10,225. From this should be deducted $5,000 in respect of the value of the garage which was paid in 1994 but recorded in 1993. While the Minister may not appeal against his own assessment for 1994, the smaller amount omitted from income may be netted against the larger amount wrongly included. The net reduction of income, therefore, for 1994 will be $5,225. Penalties were assessed of almost $40,000. Mr. Rouse did not argue that this was not a case for penalties. The amount of the penalties should, however, be adjusted to reflect the reduction in the income for each of the years under appeal. My present view is that this is not an appropriate case in which to award costs to either party.
Addendum
[23] After I delivered these Reasons for Judgment orally on July 13, 2001, counsel for the parties were given the opportunity to make submissions as to costs. Neither of them did so, and I therefore signed judgment allowing the appeals and referring the assessments back to the Minister for reconsideration and reassessment in accordance with these Reasons, making no Order as to costs.
Signed at Ottawa, Canada, this 21st day of August, 2001.
"E.A. Bowie"
J.T.C.C.
COURT FILE NO.: 98-1745(IT)G
STYLE OF CAUSE: Glenn McCarthy and
Her Majesty the Queen
PLACE OF HEARING: Fredericton, New Brunswick
DATE OF HEARING: July 9, 2001
REASONS FOR JUDGMENT BY: The Honourable Judge E.A. Bowie
DATE OF JUDGMENT: August 3, 2001
APPEARANCES:
Counsel for the Appellant: D. Andrew Rouse
Counsel for the Respondent: Marcel Prevost
COUNSEL OF RECORD:
For the Appellant:
Name: D. Andrew Rouse
Firm: Mockler Peters Oley Rouse & Williams
For the Respondent: Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada