A B.C. Supreme Court Justice fell short of awarding damages but did take Canada Revenue Agency to task for its treatment of Prince George businessman Irvin Leroux in issuing her decision last week.
Specifically, Justice Mary Humphries found CRA breached its duty of care in claiming Leroux deliberately made false statements on his income tax and then assessed hefty penalties that were eventually overturned.
CRA had launched an investigation because of the number of personal items found when looking at his claimed business expenses when a routine audit into his income tax was launched in October 1996.
Leroux had been in the process of developing an RV park and an 11-lot subdivison on about 160 acres of land near Valemount. He had planned to sell the subdivision lots to pay off the mortgage on the RV park, referred to as lot 12.
Unfortunately for Leroux, his bookkeeping methods were chaotic.
When they visited his home, CRA auditors were presented with two boxes in which they found many personal receipts mixed in what were supposed to be business receipts and stapled together with a till tape and put in envelopes.
The auditors went through everything painstakingly and tried to reconstruct the records.
"Items such as pet supplies, shaving and hair products, restaurant meals (unless bought in Valemount), groceries, candies, ladies clothing and lingerie, toys, tobacco and many other items were disallowed," Humphries said.
The experience prompted the auditors to dig deeper and, in addition to going through his records for 1994 and 1995, they used the gross negligence provisions of the Income Tax Act to open up the statute barred year of 1993.
The auditors eventually concluded Leroux had deliberately misrepresented his income tax returns and, in September 1999, he was told he owed $619,000 in taxes, interest and penalties.
Trouble was, the CRA was wrong in its conclusion.
At issue was how to treat the logs Leroux had cleared from the land. He designated those cleared in 1993 as a capital gain but those removed in 1994 and 1995 as business income with associated losses.
The auditors found the treatment "suspicious," Humphries said in her decision, because they did not differentiate between those cleared for the purpose of building the RV park and those removed to make way for the subdivision.
Leroux eventually took the issue to the Tax Court of Canada and, in June 2005, he was found to owe just $55,938 in income tax. Later the same year, the interest and penalties were cancelled and Leroux was owed a refund of about $25,000, which was offset against outstanding goods and service tax payments for a net result of zero.
Leroux did not help his own cause, according to Humphries, saying he did not provide any useful information to assist auditors in understanding why the income from the logs cleared in 1993 should be treated as capital gains.
But by the same token, she said it did not appear Leroux was trying to hide anything.
"He was cooperative and signed all the authorizations to obtain information," Humphries said. "However, he was busy trying to cope with setting up the RV park and simply did not stop and come to grips with what was going on with CRA, nor did he get [his accountant] to do so."
Conversely, Humphries noted a double standard on CRA's part because it defended its confusion over what can be allowed as a capital gain by emphasizing the complexity of the issues involved and the fact that the law around the "matching" of income to expenses was in flux at that time.
Humphries said it is "simply not logical" to assess penalties against Leroux for being grossly negligent over a matter the CRA itself admitted is difficult and complex.
To call Leroux's actions grossly negligent "and to assess huge penalties as a result, ostensibly for the purpose of getting around a limitation period, is unacceptable and well outside the standard of care expected of honourable public servants or of reasonably competent tax auditors," Humphries said.
The amount Leroux was subsequently found to have owed would have left anyone, "astonished and disheartened," Humphries said, but in the end she decided Leroux was not eligible for any damages, largely because he failed to file an appeal before the amounts were registered against his property, waiting 18 months to take that action.
Humphries also concluded Leroux's problems with Business Development Canada, which provided the mortgage for his venture, "were well underway before the income tax judgment was registered in July of 2001."
