Unreported Income, Gross Negligence Penalty

Thursday, February 14, 2013

Case Citation

Murugesu v. The Queen (2013 TCC 21) [TCC] [CanLII]

Summary

A taxpayer and his corporation were engaged in placing workers with a farm in southern Ontario. As an immigrant with limited knowledge of language, laws etc. he relied on an accountant to prepare his personal tax return and those of his corporation. In doing so, the reported amounts did not reflect the facts. CRA sought to assess him and the corporation for unreported income as well as apply the gross negligence penalty under 163(2) of the Income Tax Act.

Part of the confusion lies with the fact the corporation paid some workers in cash and thus while the revenue of the corporation was understated, its cash payments for wages was also understated—a fact lost on the CRA and hence this appeal.

To the extent any funds paid from the corporation to the taxpayer were not included in income, the respondent (CRA) did not provided sufficient evidence to refute the testimony of the taxpayer.

Since the judge found no unreported income with his personal tax return, there could be no gross negligence penalty. That was not the case for the corporation, a portion of the assessed amount was unreported but did the penalty apply?

The burden is on the government to show the taxpayer acted in a way that warrants the gross negligence penalty. They could not. The judge found the taxpayer was a credible witness who unknowingly relied on an incompetent accountant. Further, the notion the penalty was assessed primarily based on the quantum of the unreported income was not relevant in determining if a person “knowingly, or under circumstances amounting to gross negligence” made a false statement in a return.

It seems to me a more thorough investigation by the CRA would have avoided this appeal. It appears they made assumptions instead of gathering facts about the taxpayer’s situation.

Issue

[14] I will first consider the Corporation’s appeal with respect to its 2002 fiscal year. The sole issue before the Court is whether the Corporation incurred an expense for wages in excess of the $301,305 reported on its 2002 income tax return.

[29] As I noted previously, the Minister assumed that Mr. Murugesu appropriated all of the unreported income of the Corporation. As a result, she included the amount of the unreported income in his income under subsection 15(1) of the Act on the basis that the Corporation had conferred a benefit on Mr. Murugesu.

ITA / ETA

| 15(1)—Benefit conferred on shareholder |
| 163(2)—False statements or omissions |

Cases Cited

| Venne v. Canada ([1984] C.T.C. 223) |

Analysis

[11] Mr. Murugesu does not know why his accountant understated the Corporation’s gross revenue. He accepts that the Corporation did understate its gross revenue by $171,142 on its income tax return; however, he argues that the First Accountant also substantially understated the Corporation’s wage expense. As a result, the unreported income is substantially less than $171,142. He also argues that the Corporation should not be subject to a gross negligence penalty.

[12] The Minister assessed Mr. Murugesu personally in respect of the $171,142 of purported unreported income. She included in his taxable income a $171,142 shareholder benefit pursuant to subsection 15(1) of the Income Tax Act (the “Act”) and imposed a $22,560 gross negligence penalty.

[23] I have reviewed the numerous time cards for the workers paid in cash that are included in Exhibit A-1. I agree with counsel for the Respondent that the hourly rates shown on the time cards are lower than the hourly rates used to calculate the Corporation’s fees. This is consistent with Mr. Murugesu’s testimony. Further, in my view, it shows that the Corporation has not attempted to overstate the cash wages it paid to certain of its workers.

[27] Exhibit R-12 provides a breakdown of the $301,305 that the First Accountant reported on the Corporation’s 2002 income tax return as wages. This breakdown shows that $59,917 of the $301,305 was for cash wages. As a result, I have concluded that the Corporation understated by $88,856 the wages reported on its 2002 income tax return. This represents the difference between the actual cash wages of $148,773 and the amount reported by the accountant, $59,917.

[28] In summary, the Corporation understated its 2002 income by $82,286, that is, the difference between its unreported gross revenue of $171,142 and the $88,856 understatement of its cash wages.

[38] I do not find the schedule particularly helpful. It certainly does not support a finding that Mr. Murugesu appropriated the $82,286 of income that the Corporation failed to report on its income tax return.

[39] The withdrawals identified by Ms. Moore [CRA Investigator] would appear to consist of the wages paid to Mr. Murugesu ($52,182), whatever wages the Corporation paid to Mr. Murugesu’s spouse and a portion of the $148,773 in cash payments that the corporation made to its workers.

[40] It is my view that the objective evidence before me supports Mr. Murugesu’s testimony that he did not appropriate any amounts from the Corporation.

[41] The Minister levied gross negligence penalties in respect of Mr. Murugesu’s 2000, 2001 and 2002 taxation years. The Minister also levied a gross negligence penalty of $11,227 in respect of the Corporation’s 2002 taxation year.

[42] Since I have found that Mr. Murugesu did not receive a shareholder’s benefit in 2002, the penalty in respect of his 2002 taxation year will be removed.

[44] Pursuant to subsection 163(3), the burden of establishing the facts justifying the assessment of the penalty is on the Minister.

[45] As Justice Strayer stated in Venne v. The Queen, [1984] C.T.C. 223 (FCTD) at 234:

. . . “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 . . . .

[46] Ms. Moore testified that she made the decision to levy the gross negligence penalties. She testified that she based her decision on the magnitude of the unreported amounts, the fact that Mr. Murugesu and the Corporation made cash withdrawals and the fact that Mr. Murugesu used some of the cash withdrawals to purchase a new condominium. She also referred to a “rough source and applications of funds” analysis. However, the Respondent did not provide the Court with the analysis.

[47] Ms. Moore testified that she never had a conversation with Mr. Murugesu or any employee of the Corporation. Notwithstanding the fact that Sargent Farms had provided her with the employees’ time sheets, she was not aware that the Corporation paid some of its employees in cash.

[48] After reviewing all of Ms Moore’s testimony, it appears to me that she based her decision to levy the gross negligence penalties primarily on the magnitude of the unreported income. This in my view is not a sufficient fact, in and of itself, to justify the imposition of the gross negligence penalties.

[49] Mr. Murugesu testified that, because of his very limited understanding of English and the Canadian taxation system, he relied on the First Accountant to properly prepare and file his tax returns. He had no idea that the tax returns filed by the First Accountant were incorrect.

[50] Once an official from the CRA came to his home to discuss the problems with regard to his tax returns he immediately fired the First Accountant and hired a new accountant.

[51] Counsel for the Respondent did not adduce any evidence either through Ms. Moore or through his cross-examination of Mr. Murugesu that would undermine Mr. Murugesu’s credibility. As I noted previously, I found Mr. Murugesu to be a credible witness.

Decision

[56] Accordingly, the Corporation’s appeal in respect of its 2002 taxation year is allowed with costs. The reassessments are referred back to the Minister for reconsideration and reassessment on the basis that the Corporation, when filing its income tax return, understated its income by $82,286. The subsection 163(2) gross negligence penalty will be vacated.

[57] Mr. Murugesu’s appeal in respect of his 2000, 2001 and 2002 taxation years is allowed with costs. The reassessments are referred back to the Minister for reconsideration and reassessment on the basis that no amount should be included in his income for the 2002 taxation year under subsection 15(1). All subsection 163(2) penalties will be vacated.

Note

A paragraph beginning with a number in square brackets is a direct quote from the case.