Bachmann v. R. – TCC: Bank deposit analysis used to support assessment of shareholders on unreported income

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Bachmann v. The Queen
(February 27, 2015 – 2015 TCC 51, Woods J)

Précis: The Bachmann brothers, Dieter and Alfons, were the sole shareholders of Bachmann Automotive Limited (the “Corporation”). The Corporation was in the business of automotive repairs and the sale of used cars. CRA used a bank deposit analysis method to assess the Bachmanns and the Corporation for unreported income in 2007 and 2008. The Court rejected the argument that the deposits arose from the sale of various items of personal property several years earlier which had been held in cash until it was deposited with their bank in 2007 and 2008 and sustained gross negligence penalties in respect of most of the amounts at issue. The Court also rejected the argument that there had been no shareholder benefits since the Corporation already owed substantial amounts to the brothers. The Court did however hold that the Minister had not demonstrated gross negligence in respect of small amounts incorrectly added to the brothers’ shareholder loan accounts and ordered the penalties deleted in respect of those amounts.

Decision: Dieter and Alfons Bachmann were the sole shareholders of the Corporation. They were the sole employees of the Corporation which was involved in car repairs and used car sales. Much of its business was done with cash. They and the Corporation were assessed for 2007 and 2008 in respect of unreported income:

[2] The appellants are two brothers, Dieter and Alfons Bachmann, and a corporation wholly-owned by them, Bachmann Automotive Limited. The assessments relate to the 2007 and 2008 taxation years.

[3] In the bank deposit analysis, the appellants’ bank deposits were compared with the gross income reported by the corporation. To the extent that the deposits were not explained to the satisfaction of the Canada Revenue Agency (CRA), the amounts were added to the corporation’s income on the assumption that the source of the funds was revenue from the corporation’s business. In addition to assessing the corporation, the shareholders were assessed on the assumption that unexplained deposits in the shareholders’ personal bank accounts were benefits received by the shareholders from the corporation.

[4] The assessments also included relatively small amounts that were added to the shareholders’ income on the assumption that benefits were received as a result of incorrect accounting entries to the shareholders’ loan accounts.

[5] The Minister also assessed gross negligence penalties with respect to all of the amounts added to income.

Their defence was that the Corporation’s income had all been reported and the bank deposit analysis method was inaccurate because the deposits came from personal sources such as savings and the sale of personal assets.

The alleged under-reporting amounted to $44,440 and $39,504 for the 2007 and 2008 taxation years, respectively. The Court first noted that bank deposit analysis can be an appropriate basis for assessment. It also noted that the bulk of the deposits in question were to the brothers’ personal accounts, not that of the Corporation:

[19] The general basis for the assessments was a bank deposit analysis. In the relevant taxation years, each of the appellants had made bank deposits which were not explained to the satisfaction of the CRA and the CRA assumed that these deposits (as well as some expenses paid with cash) were sourced from revenue from the Corporation’s business.

[20] This Court has recognized that in an appropriate case a bank deposit analysis is an acceptable method to compute income. In this case, there is a large discrepancy between the gross income reported by the Corporation and the amounts added to income pursuant to the bank deposit analysis. I accept that it was appropriate to use this method in this case.

[21] The unexplained deposits in the Corporation’s bank account are relatively small, $5,147.67 for the 2007 taxation year and $1,877 for the 2008 taxation year (includes a deposit prepared but not deposited).

[22] The unexplained deposits in the Shareholders’ personal bank accounts make up the majority of the amounts assessed. Deposits were generally made by the Shareholders once a month or more.

[23] The appellants submit that there was no business income that was not reported.

The Court rejected the brothers’ argument that the source of the deposits was personal savings and the sale of personal property:

[24] The Shareholders testified that the so-called unexplained deposits were sourced from an accumulation of savings and sales of personal assets over the years. Alfons stated that the Corporation went through tough times during the well-publicized aboriginal dispute in Caledonia and that he had to sell personal assets that were accumulated during many years of employment. Each Shareholder provided a rough handwritten list of personal assets that were sold and they provided evidence of significant RRSP withdrawals in 2003. In addition, Dieter introduced evidence of a $6,000 insurance payment that was received in 2005 relating to a stolen vehicle.

[25] The appellants have the burden to establish a prima facie case. That burden has not been met.

[26] In order for the appellants to succeed, I would have to accept that the Shareholders kept substantial amounts of cash on hand over the years and deposited it into bank accounts in later years. Alfons testified that the deposits were made when funds were needed to pay bills.

[27] On its face, the Shareholders’ testimony is far-fetched and defies common sense. I find it extremely unlikely that the Shareholders would acquire significant amounts of cash and keep it on hand, sometimes for several years, until needed for expenses.

[28] In addition, the testimony was not sufficiently detailed to be believable and there is no reliable supporting evidence to link the deposits to a source of funds.

[29] Based on the evidence as a whole, I find that the appellants have failed to satisfy the burden of proof.

The Court also rejected the notion that there had been no shareholder benefits since the Corporation already owed the brothers large amounts:

[34] There is case law to the effect that amounts appropriated by shareholders are not necessarily benefits when there are outstanding amounts owed by a corporation to the shareholders. This case law is relevant in these appeals because the financial statements of the Corporation indicate that substantial amounts are owed to the Shareholders.

[35] This case law would be applicable if the appropriations by the Shareholders were due to inadvertence: The Queen v. Franklin, 2002 FCA 38. However, in Franklin, Rothstein J.A. pointed out that the decision was not to be interpreted to condone negligent record-keeping or deliberate actions (at para. 8). This exception is applicable in this case, because the evidence as a whole suggests that the failure to report the income was deliberate. Accordingly, I would conclude that the appropriations by the Shareholders determined by the bank deposit analysis are “benefits” which are to be included in income pursuant to subsection 15(1) of the Act.

The Court upheld the imposition of penalties for gross negligence with the exception of some small accounting entries to the shareholder accounts:

[42] In light of my conclusion that the Shareholders’ explanation of the deposits was not credible, it follows that each of the appellants likely knew that income was under-reported in their income tax returns by the amounts reflected in the bank deposit analysis. I find that the Crown has satisfied its burden in this respect.

[43] However, it is appropriate to vacate penalties with respect to the incorrect additions to the shareholder loan accounts. The Crown has not provided sufficient evidence to establish gross negligence with respect to this accounting entry. The evidence as a whole supports a finding of negligence, but there is not sufficient evidence to support a finding of gross negligence. I note in particular that the amounts involved are quite small. Accordingly, the penalties assessed to the Shareholders should be vacated to the extent that they relate to the incorrect additions to the shareholder loan accounts.

Finally the Court briefly rejected arguments based on an alleged lack of cooperation from the Crown, failure to pursue settlement discussions and the general unfairness of the assumption system.

The appeals were dismissed with each side to bear their own costs.