Case Commentary: Paquet c. Le Roi – Reversing the Burden of Proof from the Taxpayer to Canada Revenue Agency (CRA)

Introduction: Disproving the Inclusion of Income by the CRA

In this case, the taxpayers, Steve Paquet and his company, 4527976 Canada Inc. (“Héritage”), appealed against income tax assessments for 2010-2013 for Paquet and 2010-2014 for Héritage. The Canada Revenue Agency (“CRA”) included over $20 million in large cash sums delivered by Garda to Héritage’s address in the appellants’ income, based on L’Agence du revenu du Québec’s (“ARQ”) investigation and tax audit findings. Mr. Paquet’s appeal challenged this inclusion of income. The case focused on whether the burden of proof had been satisfied to justify the inclusion of the income. The court found that the CRA’s reassessments were inconsistent and unsubstantiated, lacking independent verification. The evidence the CRA provided was insufficient and thus the Tax Court accepted the appeals and sent the reassessments back to the CRA to be redetermined.

Background: ARQ and CRA Audit of Cash Deliveries

The appellants were engaged in wholesale poultry sales activities and named by ARQ as parties to a series of transactions in which large sums of cash were delivered to Heritage. A third party, Garda, would obtain envelopes of cash addressed to Heritage’s business address from a corporation unrelated to the Appellants, Termont Inc. (“Termont”). Garda would make weekly, or sometimes multiple times a week, cash deliveries of $15,000 to $150,000. The sole shareholder of Termont, Laurent Monette, would collect the sealed envelopes from Garda. Termont’s accountant stated that Termont used the cash to pay its suppliers. The total cash delivered from 2010 to 2014 exceeded $20,000,000. There was no evidence that the cash was given directly or indirectly to either of the taxpayers.

ARQ launched an investigation and an audit, which would later be joined by the CRA’s audit and recovery teams. ARQ’s tax audit resulted in reassessments for the two appellants. The results of ARQ’s investigation and audit were communicated to the CRA. The CRA reassessed Mr. Paquet, and the reassessments “mirrored” ARQ’s reassessments. However, the CRA reassessed Heritage on an entirely different basis. Heritage’s income was reassessed to include the total amount of cash delivered to its premises by Garda. Gross negligence penalties were also imposed on both taxpayers in respect of the amounts assessed. Both appellants challenged the inclusion of the additional income in the reassessments.

The appeal coincided with criminal proceedings before the Court of Quebec where the appellants faced the possibility of criminal liability for incorrect designations of financial transactions in their financial documents. However, the Tax Court decided that no weight for the tax appeal would be given to the conclusions and evidence in the Court of Quebec.

Burden of Proof – Reversing the Onus from the Taxpayer to the CRA

The Tax Court relying on the Supreme Court of Canada’s decision in Hickman Motors Ltd. vs. Canada, found that the appellants fully discharged any initial burden placed on them. That the appellants only had to demolish the CRA’s presumptions with at least a prima facie case. On examination, it is expected that the CRA would be able to produce concrete evidence rather than simple presumptions to refute the arguments of the taxpayers. The Tax Court concluded in this case that the taxpayers had discharged any initial burden placed on them.

The CRA’s Inability to Meet the Evidentiary Burden

Witnesses included individuals involved in the operations and tax audit processes, from both the appellants’ and respondent’s sides. The appellants additionally called as witnesses Mr. Paquet, Maria D’Amico (the receptionist who usually signed for Garda deliveries in Mr. Monette’s absence), Nathalie Paquet (administrative assistant at Héritage), Daniel Dauplaise (vice-president of Garda operations in Quebec) and Rima Skaf (ARQ auditor). Whereas the respondent called as witnesses David Sawyer (CRA collection agent), Geneviève Robillard (CRA auditor at the time of the audits) and Minyu Chiu (ARQ investigator).

Initially, ARQ had audited Termont Inc. after it did not declare any income for the 2010 to 2012 tax years. The corporation did not keep accounts or supporting documents, but, through examining bank files, ARQ found that Termont was moving cash through Garda. And that all the sums in question were delivered in cash by Garda to Héritage’s business address with the shipment being addressed to Termont. Garda obtained delivery instructions and authorization forms from Termont. The money was transferred to Garda from a Termont bank account. Mr. Monette would come to collect the sealed envelope. There was no evidence that the cash was handed over directly or indirectly to the appellants.

Why was the money sent to Heritage’s business address? Garda refused to make deliveries to a residence. Thus, Termont Inc. required a place of business that was considered safe for everyone involved. Mr. Monette passed away prior to the hearing but in his affidavit, he confirmed that he recovered all the money sent to Heritage’s address. Additionally, all the money that Termont had delivered via Garda belonged to Termont and that did not belong to either Mr. Paquet or Héritage.

The ARQ concluded that Termont and Desco were two of Héritage’s main clients. Termont’s accountant, Mr. Auger, explained to the ARQ that Termont used the cash sums to pay his suppliers to avoid attracting the attention of his bank.

Guy Chevalier was questioned by the tax authorities about his participation and what he knew of the operations. His company, Desco, was also involved in the poultry sector and had about 250 employees and revenues in the $30 million range. He explained that he had organized the operations to improve the financing of his poultry inventory and his receivables from his bank. The operations allowed his company to record in the books the sale of part of its inventory to one of the other parties concerned and to make it a debt, then an amount received, even if the operations continued since it bought the same inventories from the other company. He argued that these operations helped Desco manage its quota problems.

What happened to the cash after Mr. Monette collected it was unclear from the evidence before the court. The money could have continued to be circulated or put to other purposes. Employees from ARQ and the CRA spent five years trying to shed light on the situation surrounding the Garda cash deliveries. However, the Tax Court found that while it would be useful to know what happened to the cash, it was not necessary to answer this question. The Tax Court was only concerned about answering whether the inclusions of income for the appellants were accurate.

No details were obtained or provided regarding Desco’s banking agreements or its bank financing. Neither the CRA nor the ARQ subjected Desco to an audit in connection to the cash deliveries. Furthermore, their audits of Héritage did not identify any purchase or sale transaction between Héritage and Desco. While poultry sales were the only link between Héritage and Termont. However, to the knowledge of Héritage and Mr. Paquet, these two companies had no clients in common. The tax authorities also did not check with the bank that financed Desco’s inventory whether the explanation given by Mr. Chevalier was supported by Desco’s banking records. The evidence demonstrates the little effort made by the tax authorities, informed directly by Mr. Chevalier, to try to understand how Desco’s strategy worked and who benefited from it, to confirm or rule it out.

The CRA and ARQ produced little evidence that the tax authorities diligently sought the initial source or final recipient of this cash. The Tax Court questioned why they did not exercise their full legal powers to investigate this key further information.

Neither agency conducted a net worth analysis or a full bank statement reconciliation or used any other verification method on the appellants. The CRA was only interested in bank deposits and withdrawals concerning one of Mr. Paquet’s banks, even though it knew of at least two other banks he used for his business. The CRA did not compare his overall lifestyle or standard of living to his sources of income or capital.

There was no evidence establishing that Mr. Paquet had significant assets other than the following: his half of the mortgaged middle-class family residence, a chalet worth $300,000 in Mont-Tremblant, an expensive boat and a condo worth $500,000 in Montreal, which belonged to his company. None of the purchases were made in cash. The tax authority attempted to demonstrate that Mr. Paquet’s declared income did not explain certain purchases. However, the tax authorities had not considered that Mr. Paquet’s declared income included taxable capital gains, which meant he had a non-taxable portion of the capital gain.

Ms. Skaf carried out the verification of Termont. She confirmed that Termont had revenues of approximately $60 million. She admitted expenses of approximately $30 million. The audit did not reveal evidence that people other than Mr. Monette controlled Termont’s bank account. However, she did not examine the signed Garda receipts and did not know who signed most of the receipts, but she knew that Mr. Paquet had signed for a delivery. She found no evidence that Mr. Paquet was the beneficiary of the cash, other than the link of the cash being delivered by Garda to Heritage’s place of business. She did not ask Mr. Paquet what happened to the cash after it was delivered.

Ms. Robillard carried out the audits of Héritage and Mr. Paquet for the CRA. The Tax Court confirmed through her testimony during the hearing numerous gaps in the tax audit. For example, she did not reconcile the payments that Héritage made to Mr. Paquet; she did not determine whether Mr. Paquet deposited all his income; and she could not trace the cash. She could not say whether any cash was deposited into an account. Furthermore, she did not analyze the bank statements of Desco or anyone else to try to establish the origin of the cash, which the Tax Court noted suggests that the Respondent did not make sufficient effort to establish the provenance of the cash and to trace it. Ms. Robillard had no opinion as to whether there was any reason to doubt the testimony of any of the appellants’ witnesses in the case. Her knowledge of the Appellants and their operations likewise contained numerous gaps, such as not understanding how purchases and sales were made by intermediaries in the poultry sector, knowing who controlled Termont’s bank account, or various facts regarding Garda’s cash deliveries.

Ms. Chiu was ARQ’s investigator and through her testimony, the Tax Court confirmed various gaps in her knowledge and investigation. confirmed the following in her testimony. This includes the fact that she found no evidence indicating that the cash had been deposited into an account held by Mr. Paquet or one of his companies nor did she discover any purchases paid in cash by Mr. Paquet relating to assets or investments. She had concluded that Mr. Paquet controlled Termont, and Termont’s bank account, based on incomplete emails discovered on a computer belonging to Héritage. Ms. Chiu was to examine Desco and Mr. Chevalier, but she did not indicate to the Court what conclusions, if any, ARQ had drawn regarding their role or activities in the transactions.

The Tax Court noted that the fact that the respondent did not ask Mr. Chevalier or others associated with Desco to attend the hearing and testify allowed the Tax Court to conclude that such testimony would likely not have assisted the Respondent in meeting their evidentiary burden.

Conclusion – CRA and ARQ did not Meet the Burden of Proof

The Tax Court concluded that the evidence relating to the financial strategy of Mr. Chevalier and Desco involving the cash deliveries, according to the explanations given by Mr. Chevalier and Mr. Auger, could just as easily explain the cash deliveries as the CRA’s and ARQ’s explanation. The Tax Court found that the evidence and statements of Mr. Monette were compatible with Mr. Chevalier’s explanation. Furthermore, the evidence did not indicate that one or both of the appellants profited for personal gain from all or any of the cash delivered by Garda. The Tax Court concluded that Mr. Chevalier, and other witnesses, all gave versions of the facts that would run counter to such a conclusion. The information produced during the hearing implicated people other than Termont, Mr. Monette, Héritage and Mr. Paquet. Thus, on the balance of probabilities, the Tax Court could not conclude that the assessments in dispute are supported by the facts in evidence.

The tax authorities did not produce sufficient evidence to demonstrate that the assessments were accurate, nor did they succeed in dismantling the credibility of the testimonies of the appellants’ witnesses. Therefore, the tax appeals were allowed.

Pro Tax Tips: Powers of the CRA

The Tax Court highlighted during this case that the CRA did not make use of the investigatory powers that it is provided under the Income Tax Act (“Tax Act”). For instance, sections 231 and 237 of the Tax Act provide broad powers for the CRA to demand documents and information, including the ability to dictate in what form the information is provided. If they had used those powers, then this case may have turned out very differently or maybe they would have discovered what happened to the cash deliveries. However, the powers the CRA has are not limitless. An expert Canadian tax litigation lawyer would be an appropriate line of defence to help ensure you are compliant with appropriate requests and protected against overreaching CRA demands.

FAQ

If I face a similar situation with wrong assumptions by the CRA, then how can I meet the initial burden of proof?

The Supreme Court of Canada case of Hickma to n, which was relied on in this case, is one of the leading cases. During that case, the Supreme Court of Canada found that the appellant had produced “clear, uncontradicted evidence, while the respondent did not adduce any evidence.” Therefore the appellant had surpassed its initial burden. The Supreme Court of Canada in that case clearly stated the assumptions made by the CRA, and how the appellant produced evidence to the opposite of the assumptions. A similar method should be taken in other situations. Other appellants should determine the assumptions of the CRA, and then assess the evidence they have for refuting the assumptions. An expert Canadian tax litigation lawyer would be knowledgeable on the type and extent of evidence needed for this.

Do I need disprove all of the CRA’s assumptions?

In certain situations, even if some assumptions are demolished, the remaining assumptions could be sufficient to support the CRA’s assessment. Thus, success hinges on the ability of the taxpayer to identify to demolish CRA’s assumptions that are necessary for the assessment. To accomplish this, the experienced Canadian tax litigation lawyer representing taxpayers needs to draft a well-written legal pleading that defines the facts and issues in dispute and the remedies sought by the taxpayer.

Disclaimer: This article just provides broad information. It is only up to date as of the posting date. It has not been updated and may be out of date. It does not give legal advice and should not be relied on. Every tax scenario is unique to its circumstances and will differ from the instances described in the article. If you have specific legal questions, you should seek the advice of a Canadian tax lawyer.

About the Author

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David J. Rotfleisch

David J. Rotfleisch, a leading Canadian tax lawyer, is not only a certified specialist in taxation but also a chartered professional accountant. Most recently, David is a pioneer in Canadian crypto taxation.

As of April 2020, he was one of 12 Ontario Certified Specialists In Taxation™.

Learn more about David J. Rotfleisch