Bondfield Construction Company (1983) Limited v. The Queen

Bondfield Construction Company (1983) Limited v. The Queen
Court (s) Database
Tax Court of Canada Judgments
Date
2005-05-18
Neutral citation
2005 TCC 78
File numbers
2001-967(GST)G
Judges and Taxing Officers
Diane Campbell
Subjects
Part IX of the Excise Tax Act (GST)
Decision Content
Docket: 2001-967(GST)G
BETWEEN:
BONDFIELD CONSTRUCTION COMPANY (1983) LIMITED,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
____________________________________________________________________
Appeal heard on September 22, 23 and 24, 2003, October 21 and 22, 2003 and February 23, 24, 25, 26 and 27, 2004 at
Toronto, Ontario,
Before: The Honourable Justice Diane Campbell
Appearances:
Counsel for the Appellant:
Timothy Danson and Robert Zigler
Counsel for the Respondent:
Margaret Nott and André LeBlanc
____________________________________________________________________
JUDGMENT
The appeal from the assessment made under Part IX of the Excise Tax Act, notice of which is dated December 22, 2000 and bears number 582 in respect to the period January 1, 1991 to November 30, 1995 is allowed and referred back to the Minister of National Revenue for reconsideration and reassessment in accordance with the attached Reasons for Judgment on the basis that the period January 1, 1991 to June 5, 1994 is statute barred and the penalties will be deleted. The input tax credits claimed in respect to the back-charges, to the extent they are not statute barred, will be disallowed.
Two sets of costs are awarded to Appellant counsel.
Signed at Ottawa, Canada, this 18th day of May 2005.
“Diane Campbell”
Campbell J.
Citation: 2005TCC78
Date: 20050518
Docket: 2001-967(GST)G
BETWEEN:
BONDFIELD CONSTRUCTION COMPANY (1983) LIMITED,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Campbell J.
[1] This is an appeal from a Goods and Services Tax (“GST”) reassessment under Part IX of the Excise Tax Act, R.S.C. 1985, c.E-15, as amended (the “Act”), for the period of January 10, 1991 to November 30, 1995.
[2] By Notice of Assessment dated June 5, 1998, the Minister of National Revenue (the “Minister”) assessed the Appellant for the period as follows:
Adjustments to GST/HST $ 658,547.82
Adjustments to Input Tax Credits 300,433.05
Total Adjustments for Assessment Period $ 959,007.87[1]
Penalty 417,560.26
Interest 358,564.55
Other penalty [gross negligence] 232,510.10
Amount Owing $1,967,642.78
[3] By Notice of Reassessment dated December 22, 2000, the Minister reversed the gross negligence penalty of $232,510.10, and made other adjustments as follows:
Period/Période
1991/01/10 to 1995/11/30
Reported Amount
Montant Reporté
A
Per Audit
Per Appeals/Selon les appels
Assessed
Cotisation
B
Adjustment
Ajustement
C
Reassessed
Nouvelle cotisation
D=(A+B+C)
Net tax-Taxe nette
$543,580.94
$959,007.87
($217,483.24)
$1,285,105.57
Rebates-Remboursements
0.00
0.00
0.00
0.00
Net Interest to:
- Intérêt net au:1998/06/05
358,564.55
(77.26)
$358,487.29
Penalties to:
- Pénalités au:: 1998/06/05
650,070.36
(256,666.16)
$393,404.20
Refund Amount or Amount Owing-
Remboursement ou Montant dû
$1,967,642.78
($474,226.66)
$1,493,416.12
[4] During the hearing the Respondent conceded that the statutory penalty and interest should be reduced as follows (Exhibit R-2):
Statutory penalty $ 82,267.10
Interest 92,308.99
Total $174,576.09
[5] The Appellant takes issue with the assessment of the statutory penalty and the Minister’s disallowance of Input Tax Credits (“ITCs”). The ITCs at issue were related to invoices where the amount owing on the invoice, including the GST, was “back-charged” to a subcontractor. The total of the ITCs in dispute here is $153,648.88. The Appellant also argued that the Minister was statute barred from reassessing on GST returns respecting the period prior to June 5, 1994. If the Appellant is successful in arguing the statute barred period, a portion of the ITCs would also be statute barred. In other words, the Appellant takes issue with the entire amount of back-charges reassessed at $153,648.88, a portion of which may be statute barred.
[6] The Appellant does not disagree with the Minister’s reassessment of the GST on PST (provincial sales tax) issue, except to the extent that a portion may be statute barred. The Appellant submits that the following amounts are statute barred (Exhibit A-1, Tab 11):
Under-remitted GST on sales $393,662.34
Disallowed ITCs (back-charges) $94,777.46
Evidence
[7] The Appellant called two witnesses: Ralph Aquino, president and sole shareholder of the Appellant; and Susan Farina, a chartered accountant and partner with Goldfarb, Shulman, Patel & Co.
[8] The Respondent called four witnesses: Jin Pyeon, a technical advisor with Canada Revenue Agency (“CRA”); Chander Sudan, a chartered accountant and partner of the accounting firms which provided advice to the Appellant; Gail MacNeil, a team leader with the special investigations unit of CRA; and Lisa Kelly, an appeals officer.
The Appellant’s Evidence
Ralph Aquino
[9] Ralph Aquino was born in Italy and came to Canada in 1961 at 18 years of age. He has little formal education, having completed Grade 5 in Italy. After moving to Canada he worked in the construction industry for 13 years, learning the business, gaining expertise in reading architectural plans, and tendering on large projects and concrete work. In 1974, he opened his own small business which today has grown into a company which handles approximately $300 million dollars annually in projects. In 1991, the year the GST was introduced, the Appellant company was doing approximately $100 million dollars in business. Today, the Appellant employs 35 people at its head office to track projects and an additional 15 on site in the project field. During the years 1991 to 1995, the Appellant employed 15 employees in the office and five to six in the field.
[10] The Appellant company is an institutional builder, constructing large buildings such as schools, hydro plants, municipal buildings and hospitals. The Appellant itself completes the excavation and concrete work (which comprises about 20% of each construction project) and it hires subcontractors to complete the remainder of the project. Mr. Aquino oversees each of these complicated projects in its entirety, but his expertise is being able to envision what a building will look like from the documents containing the plan. In putting the whole package together, he spends most of his time on site at the project. He explained that a routine work day for him began very early in the morning, organizing his employees and meeting with estimators and staff. The balance of the day and the majority of his time is spent at the project site. His knowledge of and expertise in this business were obtained through hands-on experience in the first 13 years working as an employee in the industry.
[11] Mr. Aquino has had no training or knowledge respecting accounting practices for projects of this size. He recognized this weakness and hired in‑house staff and off-site accountants as early as 1976. In 1985, the Appellant hired a chartered accountant named Bishwajeet Kar to act as the company’s comptroller. In this capacity, Mr. Kar was in charge of and responsible for all accounting matters including the accounting staff.
[12] In March 1989, the Appellant also engaged the external accounting firm of Pannell Kerr MacGillivray to provide audited financial statements. Mr. Aquino testified that Mr. Kar was familiar with this firm and knew one of its representatives (Mr. Sudan) personally; and it was on Mr. Kar’s recommendation that he chose this firm. In its engagement letter to the Appellant (Exhibit A-1, Tab 1), the firm set out its function and responsibilities and the basis of its anticipated fees. In the early 1990s, the Appellant paid between $25,000.00 and $30,000.00 per year in fees to the external accounting firm. Mr. Kar was the Appellant’s principal contact with the external accounting firm. Each year an engagement letter was written to the Appellant and Mr. Kar brought the letter to Mr. Aquino’s attention.
[13] On July 4, 1990 (i.e. prior to the introduction of the GST on January 1, 1991), Terry Dooley, a partner at the external accounting firm, wrote to the Appellant advising that the proposed tax would impact on the company’s operations respecting its established accounting systems (Exhibit A-1, Tab 2). Mr. Dooley also advised the Appellant that his accounting firm was in the process of drafting and forwarding a GST checklist for the company’s review which aimed to identify issues or potential problems regarding this new tax. Without such professional help, Mr. Aquino testified he would be absolutely unable to properly implement the new GST regime to enable his company to deal with the tax. His view of the implementation of the new tax was that it would be “...very messy and very complicated” (Transcript page 32).
[14] Mr. Aquino stated that through the years, the company’s comptroller, Mr. Kar, “... became part of a family and friends” (Transcript page 31). In 1994, Mr. Aquino gave far more responsibility to Mr. Kar in order to free himself to care for his ailing wife who subsequently died in December of that year. He was comfortable giving Mr. Kar the additional responsibility as they had developed a close relationship over the years. He stated he had no reason to doubt the expertise, competence or advice he received from Mr. Kar or from the external accountants.
[15] Mr. Aquino testified that he took comfort in the fact that the company had outside accountants reviewing and monitoring his staff and their accounting activities. He explained that even if he had the education to review the GST accounting procedures, he would still have to depend on such people as it was too big a job in a company that did the volume of work that the Appellant did (e.g. during the early 1990s the Appellant paid on average half a million dollars in GST each month). Mr. Aquino testified that he did not hire an additional external accounting firm specifically to complete a GST compliance audit because he felt the firm he had hired would inform the Appellant of any GST problems. Mr. Aquino went on to state:
…I cannot tell you what an accountant should do because I don’t know, but I can tell you if somebody comes in my office and doesn’t see that I pay enough GST, he should not come through that door.
… If I have to hire the third person, then I will… (Transcript page 127)
[16] The company’s audited statements were reviewed with Mr. Aquino each year before they were filed with Revenue Canada. During the period in issue, the external accountants never indicated to him that there were any problems with the GST procedures nor did they raise any concerns over the internal systems that the Appellant had in place to deal with and monitor the GST. Likewise, the company’s comptroller, Mr. Kar, never indicated to Mr. Aquino that there was anything wrong with the company’s treatment of the GST. Mr. Aquino also recalled that Revenue Canada’s auditors attended the corporate premises three or four times between 1991 and 1995 to conduct audits but never indicated that there was any problem with the treatment of GST. Mr. Aquino’s evidence was that the Appellant’s treatment of GST was clearly recorded in the corporate books.
[17] The Appellant’s year end is December 31. Every March, the external accountants attended at the Appellant’s office and would take from two to three weeks to complete the audit. The external accountants reviewed the various ongoing construction projects and asked Mr. Aquino questions relating to the jobs, such as percentage of work completed on a project and equipment details. In May, the draft audits would be presented to the Appellant for review. Mr. Kar reviewed these drafts with Mr. Aquino as Mr. Aquino did not have the expertise to personally review them. In June, the external accountants would visit the company premises again to review the final statement and returns with Mr. Aquino and Mr. Kar to advise on the amount of tax that the Appellant would owe.
[18] Mr. Aquino confirmed that in June, in each of the years from 1990 to 1994, one or two weeks prior to the date for filing and paying tax, he and Mr. Kar met with Mr. Sudan, the representative of the external accountants, to review the audited financial statements. Mr. Sudan never discussed GST issues with Mr. Aquino and he never raised the Appellant’s practice of maintaining two sets of invoices for each transaction: one set that went to customers contained a higher GST amount than the set of invoices that was kept in‑house. Mr. Aquino testified that he did not know, and could not have known, that Mr. Kar maintained two sets of invoices because he was unable to go into a computer to check the books. He knew nothing about bookkeeping and hired external accountants as an additional check on his business to ensure everything was done within the law.
[19] Mr. Aquino gave evidence that at no time during these meetings, or at any other time, did anyone bring to his attention any issues or problems respecting the manner in which the Appellant dealt with GST. Throughout the years in question, there was no indication from either the external accountants or Mr. Kar that there might be difficulties with the Appellant’s GST reporting.
[20] Mr. Aquino confirmed that he did not ask the company’s comptroller, Mr. Kar, for information regarding the financial statements or discuss the GST filings because “...the education I have I couldn’t help him in the accounting” (Transcript page 92). If Mr. Kar asked Mr. Aquino anything respecting the GST filings, Mr. Aquino simply told Mr. Kar to make sure it was done properly and within the law and that if he had to employ someone else to assist him then he should do so. He gave Mr. Kar wide authority to do his job of maintaining the corporate books and records.
[21] Mr. Aquino never went through the GST documentation himself to ascertain whether GST was being properly collected, reported and remitted or if ITCs were being properly claimed. He stated that even if he had had the time to go over the massive amount of bookkeeping, given his lack of formal education, he would have been incapable of reviewing and understanding the accountants’ work.
[22] Mr. Aquino was unaware of any problems until Mr. Kar’s employment was terminated in late November 1995, when he was caught removing a box of documents from the head office. This was in the year following his wife’s illness and death in 1994, during which time Mr. Aquino had delegated additional authority to Mr. Kar.
[23] Grant Dickinson, who replaced Mr. Kar in mid-December 1995, discovered the GST filing problems and brought them to Mr. Aquino’s attention by mid‑January 1996. Mr. Aquino advised him to rectify the problems immediately that same month. He stated he was “… really shocked, by having all those people around me” (Transcript page 44) and yet no one ever informed him there could be a problem. In addition to the GST reporting problems, Mr. Dickinson informed him that the corporate records disclosed that Mr. Kar had defrauded the Appellant of $940,000.00. At the suggestion of his lawyer, the Appellant hired a forensic accounting firm to investigate. The investigative report, which cost the Appellant a further $150,000.00 (Exhibit A-2), resulted in the eventual conviction of Mr. Kar for defrauding the Appellant; however, no restitution was ever paid to the Appellant.
[24] On June 5, 1998, the Appellant was reassessed in the amount of $1,967,642.78 and on June 19, 1998, the Appellant issued a cheque for payment of this amount. Although he almost lost his company, he testified that he instructed that this payment be made immediately upon reassessment because he did not want any further problems.
[25] The Appellant subsequently replaced its external accountants, initially with the accounting firm of Ernst & Young, and eventually with the firm of Goldfarb, Shulman, Patel & Co.
The Evidence of Susan Farina
[26] Susan Farina is a partner at the firm Goldfarb, Shulman, Patel & Co., the Appellant’s current external accountants. She testified that her firm completes the Appellant’s corporate returns and provides the Appellant with audited financial statements and advisory services. As a part of the auditing process, the firm reviews a client’s GST compliance to ensure the financial statements are free of material misstatements.
[27] Ms. Farina explained that an accountant can be employed to draft financial statements at three different levels. The highest level of involvement (and most expensive) is to be engaged as an auditor. At this level, an auditor
...examines the evidence underlying the amounts in the financial statements, as well as the disclosures in the notes to the financial statements. The auditor considers the appropriateness of the accounting principles used and the overall presentation of the financial statement. At the conclusion of the engagement, assuming the auditor has no reservation, the auditor expresses that in its opinion the financial statements, in all material respects, are free from misstatement and are in conformance with generally accepted accounting principles. (Transcript page 151)
Ms. Farina’s firm is currently engaged with the Appellant at this highest level. Similarly, during the period at issue in this appeal, the external accounting firm (Pannell Kerr MacGillivray) was appointed by the Appellant to provide a full audit. While many corporations of the Appellant’s size use this audit level, there are many others that use the second highest level of engagement (the review level) and still others that use the lowest level.
[28] Ms. Farina explained the measures her firm undertakes with respect to GST when engaged at the highest level. To ensure the appropriate systems are in place and that there is compliance, a questionnaire is completed. This questionnaire addresses specific areas, where concerns could arise, and identifies on a month‑to‑month basis the figures reported on the GST returns, in particular, the sales, GST collected and ITC amounts reported. Total sales as reported on the GST returns are then compared to total sales in the corporate records, and where necessary, adjustments are made. She explained that these types of activities are not specifically documented in the audit engagement letter to the clients. Rather, the letter simply indicates that in making inquiries, the firm will have access to the clients’ records and staff. Ms. Farina stated that the number of accounting staff employed by the Appellant during the relevant period was very similar to the number it presently employs.
[29] Ms. Farina outlined the steps the Appellant takes to ensure compliance with the law in operating its business. Firstly, the Appellant employs a comptroller to supervise its in-house accounting staff and oversee the entire accounting operation, including the filing of the monthly GST returns. The comptroller acts as a liaison between the Appellant and the external auditors and is the main contact person in the company during the audit process. To the best of her knowledge, Mr. Kar, the company’s comptroller during the relevant period, had an educational background and industry experience comparable to the individuals hired by the Appellant after he was fired. Secondly, the Appellant maintained a premier accounting software system and employed accounting procedures used by similar general contracting companies. This system and the procedures the Appellant utilized were in her words:
…designed to ensure that all of the information that’s relevant to the computation and compliance with the GST rules is captured within the books and records of the corporation. (Transcript page 165)
Finally, the company hired reputable external auditors to provide an additional level of comfort that the internal accounting activities were being appropriately applied.
[30] In addition, Ms. Farina said that the Appellant has always been co-operative and receptive to suggestions for changes to its system. She pointed out that some of the changes her firm recommended, when they took over the account, cost the Appellant additional money to implement.
[31] Ms. Farina reviewed the figures on both the assessment of June 8, 1998 and the adjustments made on the reassessment of December 22, 2000 (Exhibit A-1, Tab 9 – CRA working papers for the reassessment). In addition to penalties and interest, she identified the issues as being related to the treatment of GST, where there was a “back-charge”, and to the calculation of GST on PST.
[32] Ms. Farina outlined the procedure where the problems with GST arose in applying back-charges. In any project, the Appellant hired subcontractors to complete about 80% of the work. Sometimes a subcontractor’s work was deficient. If this subcontractor was unable or unwilling to rectify his work then the Appellant would engage a second subcontractor to remedy the work and this second subcontractor would invoice the Appellant. Ms. Farina gave the example of a drywall subcontractor who causes damage to the electrical work: since the drywall subcontractor has no expertise in rectifying electrical problems, a second electrical contractor is called in to correct the work. In circumstances such as these, it was the Appellant’s practice to claim ITCs on the amount payable to the original subcontractor for the drywall work and also on the amount payable to the second subcontractor for the remedial electrical work.
[33] The Appellant’s accounting department would then record a “back-charge”, in the sub-ledger kept for the original subcontractor, equal to the amount of the invoice (including the GST). The result of the back-charge was a reduction in the amount the Appellant would pay the original subcontractor. The accounting department would then forward the invoice along with a letter to the original subcontractor. This letter notified the subcontractor of the back-charge and requested that the subcontractor issue a credit note equal to the amount of the invoice (including the GST).
[34] The original subcontractor could either challenge the back-charge or accept it. If it is challenged successfully, the back-charge is reversed, the Appellant remains liable for the invoice and no GST issue arises with respect to the Appellant claiming the ITCs on that invoice. It is where the original subcontractor accepts the back-charge that the GST issue arises. Ms. Farina referred to the example at Exhibit A-1, Tab 15 and explained the procedure, followed by the Appellant, as follows:
The example under Tab 15 is a situation where a back‑charge was raised and was not reversed. So the procedure is that the project manager requests that the accounting department prepare the back‑charge notification. The project manager signs the back‑charge notification. The accounting department assigns a number to the back-charge, which is typically prefaced with B/C, denoting back-charge and then before sending the back-charge notification out to the subcontractor, the accounting department records the back-charge in the sub-ledger for the particular subcontractor.
Now the sub-ledger is the document within Bondfield's books and records that tracks the contract with the subcontractor. It starts out by indicating the total contract amount. It keeps track of the payments made against the contract amount. In a separate section it keeps track of the back-charges, and then the total amount to be –- remaining to be paid under the contract. (Transcript page 186)
[35] In Ms. Farina’s review of the audit working papers and other corporate documents, she found no evidence to suggest that any subcontractor ever issued a credit note in respect of any back-charge; and, apart from the letter of notification, there was no other document purporting to be a debit note. The December 22, 2000 Notice of Decision (Exhibit A-1, Tab 7) referred to these notification letters as debit notes, however Ms. Farina testified that they were not debit notes for several reasons. Firstly, the letters clearly indicated that they were simply a request to start discussions on back-charges. It is plain, she noted, from the document that the Appellant was prepared to discuss and perhaps reverse the notification of the back‑charge. Secondly, the documents were in letter format and were not referred to as debit notes. Under general accounting principles, she would not classify these notification letters as debit notes for the purposes of GST. Finally, in order to be viewed as a debit note – upon which the recipient and supplier could adjust GST pursuant to subsection 232(3) of the Act – the letter must contain certain prescribed information, and these letters did not contain that information.
[36] Ms. Farina reviewed the second issue respecting the calculation of GST on PST. To understand this issue, she provided an overview of how payment requests are generated in the construction industry. A contractor such as the Appellant does not produce the invoice. Rather, they are produced by the architect or engineer for the customer. The process is instituted when the general contractor (the Appellant here) on the last day of each month sends an application for payment or progress billing to the customer’s architect or engineer. The architect or engineer inspects the progress of the project and, if satisfied, prepares a progress certificate (certificate of payment), certifying the approved amount of billing. Both the application for payment and the progress certificate (certificate of payment) include GST on the full contract price for the particular month. The contract price includes amounts paid for both labour and construction materials. Since the construction materials would have been subjected to PST, by charging GST on the whole contract price, GST was being charged on an inherent amount of PST.
[37] The Appellant’s comptroller, Mr. Kar, devised a calculation or a formula by which GST would be adjusted in such instances. He estimated that approximately 37% of the contract revenue related to construction materials and that this 37% included PST. The accounting department would divide the 37% amount by 1.08 (to arrive at the cost before PST) and then multiply the quotient by 8% in order to determine the amount of the PST applicable to the construction materials. The result of applying this formula was that 2.7407% of all revenue was assumed to be PST on materials. To illustrate, consider the following example:
$10,000.00 contract revenue before GST
$3,700.00 assumed to be related to construction materials ($10,000.00 x 37%)
$3,425.93 cost of construction materials before PST ($3,700.00 ÷ 1.08)
$274.07 PST on the construction materials ($3,425.90 x 8%)
[38] During the period in issue, the Appellant used this formula to reduce the amount of GST collected. Mr. Kar took the position that GST respecting the PST amount did not need to be remitted. This formula was used between January 1, 1991 and November 30, 1995 and terminated in December 1995, very shortly after Mr. Kar left the Appellant’s employment.
[39] The GST on PST was deleted by the Appellant’s accounting department by producing a worksheet for each progress billing. The original copies of these working papers were attached to each GST return for the month in question. Ms. Farina distinguished these working papers from invoices. Where an invoice should contain customer address information, the working papers did not contain such information; and where invoices should add PST and GST to the sales amount, the working papers used the PST to reduce the sales and GST amounts. These working papers were used to calculate the Appellant’s GST reduction which led to the under-remittance of GST.
[40] In Ms. Farina’s opinion, the method employed in these working papers was open and obvious. She referred to an invoice register (Exhibit R-1, Tab 5), for December 1993, where the Appellant summarized its progress billings for a particular month, setting out the sales amount, hold back amount, GST amount, and net accounts receivable. The GST amount on every progress certificate was always different than the GST amount on the sales register. From her perspective this method, used on each and every occasion, was open and obvious because:
... the invoice in any general contractor situation is the certificate that’s issued by the customer’s architect or engineer. Each and every billing amount on those progress certificates reflect a different amount than the GST that’s reflected in the invoice register. If somebody was trying to conceal the method of accounting for GST, the alternative way to have accounted for this would have been to have recorded each and every sales invoice based on the architect’s or engineer’s certificate, do a worksheet dealing with all of the billings for the particular month and making one adjustment in respect of the GST on PST on all of the invoices, so that anybody doing a sample check of one -- of several progress certificates would be able to track them into the invoice register without exception. (Transcript page 207)
and at page 208 of the Transcript she states:
... So anybody looking at the invoice register and performing a very simple reasonability test would notice right away that the GST was not 7 per cent of the sales amount minus the hold-back which is what one would expect it to be.
... if any attempt was being made to conceal this issue, it would have been possible for the adjustment that we referred to not be recorded as additional revenue but to be set up in a liability account and just simply not paid.
[41] Ms. Farina referred to Exhibit A-1, Tab 12 which contained summaries of each GST return, for each month filed by the Appellant, throughout the audit period. These summaries showed that the amounts reported for sales and other revenue were consistent with the amounts in the Appellant’s sales register, with the exception of the GST amounts. The sales register would be approximately 2.7407% lower, reflecting the formula’s application versus simply deducting 7% of the sales amount.
[42] Ms. Farina reviewed the audit working papers of the external accounting firm for the years 1991, 1992, 1993 and 1994 (Exhibit A-3). In looking at the verification processes used in each year, she confirmed that the procedures used were basically the same procedures that her firm presently employs on behalf of the Appellant. In addition, she reviewed the reasonability test, respecting GST reporting, employed in these working papers; the interim audit review checklist, which assists in doing an audit; and the management letter prepared at the end of an audit. Counsel referred Ms. Farina to a handwritten note prepared by the Appellant’s accounting department (part of Exhibit A-3, Tab 2) dated December 31, 1992. This note referred to the 2.7407% reduction respecting GST and a reference to PST being approximately 37% of the total contract. Accompanying these notes in each year were working papers of the Appellant which recounted total sales and how the formula was used to reduce the tax. She testified that if the information contained in these notes and papers (which indicated an incorrect treatment of GST) raised a concern in her mind, there were procedures she would take to deal with the issue during the audit conducted for the Appellant, particularly if it had significant tax implications.
[43] Counsel also took Ms. Farina through the significant matters memo and the interim audit review checklists of the external accounting firm but none of these documents contained any reference to the use of the formula respecting GST on PST or treatment of the GST tax. On the summary of the firm’s audit statements, the reference to commodity tax was marked as “low”, which Ms. Farina stated meant that the external auditors were evaluating the risk for that particular client, with its treatment of tax, as low.
[44] Ms. Farina noted that there were references in the auditors’ notes specifically identifying the formula devised by Mr. Kar, together with a note which stated: “Client collects GST on PST but doesn’t remit it”; nevertheless, the 1993 audit checklist made no reference to GST problems. Three issues for discussion with Mr. Aquino were identified in a handwritten note dated December 30, 1993. The first two items did not deal with GST. The third item, while GST related, dealt merely with a deduction for GST that the Appellant had taken on the entire cost of a vehicle, which was beyond the maximum allowable limit. No other GST issues, particularly the GST on PST issue, were identified in this handwritten note; yet, Ms. Farina noted, the auditors felt the vehicle issue was significant enough to be identified for discussion and remedy with Mr. Aquino.
[45] The working papers in 1993 are similar to 1992. There is again a reasonability list utilized, which compares the GST collected, by multiplying total revenue by 7% and comparing this figure to the GST amount on the client’s records. The difference in 1993 was indicated to be “past trivial”.
[46] For the 1994 reporting period, there was still no reference to GST problems in the year-end audit review checklist. The handwritten auditor’s notes raise five issues under “Points for Discussion with Mr. Kar” but none of these related to the GST problems. The significant matters memo for 1994 appeared to make the first reference to keeping two sets of GST documents, one for customers to pay and one to record GST collected on sales. This memo contained handwritten notes at its conclusion, including a reference to discussions with Mr. Kar and Mr. Aquino during their meeting in June 1995.
[47] On cross-examination, Ms. Farina did agree that the reasonability list is a list that looks at numbers including GST to see if the figures appear reasonable. However, it is not a detailed review. She also confirmed that the three different levels of accounting review, referred to in her direct examination, were in respect to the financial statements and not the GST filings. Ms. Farina stated that the objective of her firm at the audit level is to ensure that the financial statements are free of material misstatement and that they fairly represent the financial position and operations of the corporation.
[48] On further cross-examination, Ms. Farina confirmed that she formed her conclusions, respecting Mr. Kar’s development of and use of the GST on PST formula, based on CRA audit staff notes, external auditor’s working papers and conversations with the Appellant’s present comptroller. She agreed with Respondent counsel that it was based on her deductions after reviewing these various sources, rather than actual knowledge, because she was not engaged as the Appellant’s external auditor during the period in issue. Ms. Farina also agreed that she was not a member of the Appellant’s external accounting firm that was employed during the period in question and as such had no actual knowledge about the preparation of that firm’s working papers which she reviewed in direct examination.
[49] Respondent counsel also reviewed Ms. Farina’s conclusion that the Appellant’s GST recordings were done in an open and obvious manner. Ms. Farina confirmed that the sales figures reported on the GST returns agreed with the sales figures in the sales journal and that no adjustments were made in an attempt to conceal the fact that a portion of sales were calculated using Mr. Kar’s formula. Ms. Farina did not agree with Respondent counsel’s suggestion that it would be open and obvious only if one had access to both sets of documents because on its face, the GST return does not state that the GST billed was an amount slightly higher than the amount recorded on the return. Ms. Farina stated that, in her opinion, it was open and obvious because there was no attempt to alter information respecting reported sales. Ms. Farina also disagreed with the Respondent counsel’s suggestion that to determine that the GST amount reported was slightly less, one would have to look at source documents and internal records. Ms. Farina stated that if the holdback amount was subtracted from the sales amount and then the resulting amount multiplied by 7%, it was evident that the result would be higher than the entry on the report.
Respondent’s Evidence
The Evidence of Jin Pyeon
[50] Mr. Pyeon was an auditor for large GST files during the appeal period. He became involved in the Appellant’s file in 1996, focusing on the area of ITCs only. Mr. Pyeon explained that when the Appellant employed a second subcontractor to remedy deficient work, the Appellant did not adjust for the GST reimbursed on either the original contract for work performed or the remedial work contract completed by the second subcontractor. He concluded that the Appellant over claimed ITCs in respect to the reimbursement of GST to the Appellant. Mr. Pyeon reviewed the documents (Exhibit R-1) relating to these back-charges, where he found evidence that ITCs were claimed for all of the GST charged by both subcontractors. He explained that his review included not only the sub-trade ledgers but also other documents such as the purchase journal, the general ledger GST account and the cash disbursement journal.
[51] In assessing the Appellant beyond the statutory limitation period for the period January 1, 1991 to June 5, 1994, Mr. Pyeon explained why the CRA determined that the Appellant made misrepresentations with respect to these back‑charges. In making the determination he considered a variety of circumstantial factors including the following: the Appellant retained a professional accountant on staff, their accounting system was sophisticated enough to catch almost all of the numerous transactions, the accounting report made everyone in the company aware of what was happening within the company, it had external accountants, the amount was substantial and the Appellant was reimbursed for the amounts (including GST) owed to those subcontractors that completed remedial work.
[52] On cross-examination, Mr. Pyeon admitted that it was prudent for the Appellant to have such professional staff in its employment, that the Appellant had in fact a very professional accounting staff that was sufficiently large for the size of the company, that the company had a premier computer system throughout the audit period, that outside accountants were also engaged to provide audited financial statements and that for the most part, as noted in a memo in the working papers, the Appellant’s officers were co-operative. Mr. Pyeon felt it would be reasonable and prudent for the Appellant to rely on its accounting firm. He also agreed that the Appellant’s method of dealing with ITCs was consistent and that it did not try to suggest in the records that ITCs had been adjusted. Mr. Pyeon agreed on further questioning that the basis of assessing the Appellant for back-charges was based on the fact that it did not make the appropriate GST adjustments. When asked if this decision was based on section 232 of the Act, Mr. Pyeon responded:
Not the Section 232 we relied on. We relied on Section 169, entitlement to the ITC. Not 232, but 169… (Transcript page 441)
Mr. Pyeon acknowledged that section 232 deals with the issuance of debit notes but that it was not section 232 which he used to assess the Appellant. He did not know if section 232 was used in the reassessment of December 2000. Mr. Pyeon agreed with counsel’s suggestion on cross-examination that it would not be a misrepresentation if an individual took the legitimate view that section 232 applied instead of another section of the Act.
[53] Although there are three types of credit return audits, he stated that on those audits where auditors attend at a taxpayer’s premises, as they had done in this case, he would expect that audit