Thompson v. R. - TCC: Court permits statute-barred years to be opened because of unreported income

Thompson v. R. - TCC:  Court permits statute-barred years to be opened because of unreported income

Thompson v. The Queen (June 20, 2017 – 2017 TCC 115, Hogan J.).

Précis:  Mr. Thompson and his late wife set up a corporation to manage his mortgage brokerage business.  Neither was particularly sophisticated in either accounting or tax and they relied heavily on their accountant, Mr. Halford.  Mr. Halford set up a simple split year deferral method allowing them to defer taxation of their business income (the “Deferred Income”).  By late 2009 and early 2010 the Thompsons became concerned about the quality of Mr. Halford’s work.  They moved to a new accountant who had considerable difficulty getting information from Mr. Halford.  Mr. Halford eventually went out of business.  The new accountant, Mr. Jeffery, found that Mr. Thompson had under-reported income for 2005 and 2006 and Mrs. Thompson had under-reported for 2005, 2006 and 2007.  Mr. Jeffery proposed to report the unreported income in the 2009 taxation years of the Thompsons.  CRA rejected the proposal and reassessed the Thompsons for the 2005-2007 taxation years (which were otherwise statute-barred).  The only question before the Tax Court was whether the circumstances permitted CRA to open statute-barred years.  The Court concluded that there was sufficient evidence of carelessness or neglect on the part of the Thompsons to open the years in question.  Accordingly both appeals were dismissed, with one set of costs awarded to the Crown.

Decision:  Both of the Thompsons had substantial amounts of unreported income:

[3]             It is undisputed by the parties that John Thompson failed to report income of $51,836 and $91,970 received from 1140629 Alberta Ltd. (the “Corporation”) for services rendered to the Corporation in his 2006 and 2007 taxation years. It is also undisputed that Denise Thompson failed to report income of $13,994, $140,787 and $11,392 received by her from the Corporation in her 2006, 2007 and 2008 taxation years.

The problems here all stemmed from the Deferred Income:

[12]        Mr. Thompson testified that, after reviewing his personal tax return with Mr. Halford in 2005, he questioned why the income reported on his return was less than the amount of cash received from the Corporation in the period. According to Mr. Thompson, Mr. Halford explained that, because the Corporation had an August 31 year-end, part of the Appellants’ income could be deferred for at least one year (hereinafter the “Deferred Income”). This was possible because amounts received by the Appellants during the calendar year could be treated initially as a shareholders’ advance. For example, amounts withdrawn by the Appellants in 2005 could be treated as advances from the Corporation until 180 days after the August 31, 2006 year-end of the Corporation. At the Corporation’s year-end of a bonus could be accrued equal to the amounts received by the Appellants during the fiscal year of the Corporation. Provided the amounts accrued as bonuses were paid out by the Corporation within 180 days of its year-end, the bonuses would be deductible. The Appellants’ shareholder loan payable would be reduced in payment of the bonuses. In this manner the Appellants’ income tax on the income could be deferred for one year.

Counsel for the taxpayers argued, unsuccessfully as it turned out, that the Thompsons acted reasonably in relying exclusively upon Mr. Halford:

[29]        The Appellants’ counsel argues that it was perfectly reasonable for the Appellants to delegate to their accountant the responsibility to properly account for the Deferred Income because they were unable to account for or keep track of it themselves. While I appreciate that they may not have had the necessary skills to keep track of the Deferred Income, they certainly had the ability to question their accountant on whether or not it was being properly done. They could have asked for a reconciliation of the Corporation’s management expenses and the income reported by them each year.

[30]        I also observe that Mr. Thompson’s ability to spot errors was greater than that suggested by his counsel. The evidence shows that Mr. Thompson was able to identify errors in the Corporation’s draft financial statements for 2009, when he turned his attention to the matter.

[31]        When a taxpayer hires an accountant to prepare his tax return and is aware that tax planning involving a deferral strategy, such as that adopted by the Appellants, is being used to secure a tax advantage for the taxpayer’s benefit, a minimum degree of attention to or oversight over the accountant’s work must be exercised by the taxpayer. In the case at hand, the evidence shows that the Appellants exercised oversight in 2005 but failed to pay reasonable attention to the reporting of the Deferred Income thereafter. In my opinion, the absence of oversight constitutes carelessness on the part of the Appellants. Had they paid attention to the matter by asking questions, the errors on their returns could have been avoided.

Accordingly both appeals were dismissed, with one set of costs awarded to the Crown.

Comment:  The “reliance upon accountant” approach is a time honoured chestnut in the tool kit of tax lawyers.  Whether it works normally depends upon the level of sophistication of the client and the complexity of his or her affairs.  The pivotal factor in this case seems to have been that the taxpayers were aware that they were using a tax deferral mechanism in the first place and did not take reasonable steps to see that that deferred income was ultimately reported.