McLeod v. R. – TCC: Court Upholds Penalty for Claiming Fictitious Business Losses

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McLeod v. The Queen[1] (July 12, 2013[2]) dealt with penalties arising out of claims for fictitious business losses:

[5]             The assumptions of fact described in paragraph 15 of the Reply are not in dispute. They are set out below.

15.       In determining the Appellant’s tax liability for the 2009 taxation year, the Minister made the following assumptions of fact:

a)                  The Appellant was employed by Edmonton Public Schools and earned employment income of $42.670.00 in the 2009 taxation year;

b)                  In filing her 2009 Return, the Appellant claimed a net business loss of $157,196.40 as set out in paragraph 8, above;

c)                  In filing her 2009 Return, the Appellant reported a non-capital loss for carryback of $116,359.00;

d)                 The Appellant requested that the non-capital loss be carried back to her 2006, 2007 and 2008 taxation years in the amounts of $37,743.00, $38,115.00 and $40,501.00, respectively;

e)                  The Appellant claimed in her 2009 Return that the gross business income she reported was from “receipt as agent” and that the expenses she reported were “subcontract” expenses;

f)                   The Appellant accrued no income as an agent and incurred no subcontract expenses in the 2009 taxation year;

g)                  The gross business income, business expenses and net business loss claimed by the Appellant were fictitious;

h)                  The Appellant was an employee during the 2009 taxation year and had no source of income with respect to the alleged business; and

i)                    The Appellant did not have any non-capital losses to carryback to the 2006, 2007 and 2008 taxation years.

[6]             The fictitious claims referred to above were made with the assistance of third parties who held themselves out as carrying on business under the name Amed Solutions. Ms. McLeod dealt with two persons who used the names “Amanda” and “Ed.”

[7]             Amed Solutions prepared the 2009 income tax return and a carryback request, as well as proposed submissions for the Canada Revenue Agency (CRA) in the audit and objection stages.

[8]             Some of submissions by Amed Solutions are pure nonsense. The paragraph below is an excerpt from the first response given to the CRA auditor.

The terms of the private contract of agency between the free will man commonly called Colleen, of the McLeod family, who is the principal, the contributing beneficiary and the true party of interest for the fictional entity/person/trust called COLLEEN MCLEOD, which, by necessity, has become the agent in commerce for the principal; is not subject to the scrutiny of a third party entity, and therefore; any private dealings between the principal and the agent cannot be released to the CANADA REVENUE AGENCY.

The court simply did not accept that the taxpayer had any bona fide belief in the reality of the losses she had claimed:

[26]        I believe that when the 2009 income tax return was filed, Ms. McLeod thought that the plan was a good idea in the sense that she might receive refunds and the only downside risk was that the business loss could be denied.

[27]        It appears that it was only after the CRA questioned the income tax return that Ms. McLeod really started to probe the risks and be more concerned about the employment insurance. She was also concerned at that time about the impact on the divorce proceedings. In addition, Ms. McLeod told Ed in one email that she was shocked to receive the assessment. This is likely genuine because she did not foresee a risk of a large penalty.

[28]        Even if I am wrong that Ms. McLeod knowingly claimed a false business loss, it is certainly a case of willful blindness. Ms. McLeod engaged Amed Solutions to claim a large refund on her behalf. She had no prior relationship with them. If Ms. McLeod chose not to know how the refunds arose, and did not review the income tax return before mailing it, as she testified, this amounts to willful blindness.

[29]        The appeal will be dismissed, with costs to the respondent.

[30]        Counsel for the appellant asked for sympathy with respect to costs, noting that the penalty is extremely harsh in this case. The harshness appears to result in part from the formula for calculating the penalty. Under the formula, which is based on the tax that is sought to be avoided, the tax is computed at a relatively high tax rate which does not take into account that the actual tax savings would be spread over four taxation years and computed at lower tax rates (s. 163(2.1)).

[31]        I am not persuaded by an argument based on sympathy. I accept that the penalty is higher in this case than it would be in others, but the participation of Ms. McLeod in this scheme is reprehensible. The victims in this case are Canadian taxpayers – not Ms. McLeod.

Comment:  This is not a surprising result under the circumstances.

[1] 2013 TCC 228.

[2] The reasons were amended on July 18, 2013 and the amended reasons are the basis for this blog.