DEFENDING TAX EVASION CHARGES

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1 DEFENDING TAX EVASION CHARGES This issue of the Legal Business Report provides current information to the clients of Alpert Law Firm on Tax Evasion under the Income Tax Act (Canada) and the possible challenges to such assessments. Alpert Law Firm is experienced in providing legal services to its clients in tax dispute resolution and tax litigation, tax and estate planning matters, corporate-commercial transactions and estate administration. Howard Alpert has been certified by the Law Society as a Specialist in Estates and Trusts Law, and also as a Specialist in Corporate and Commercial Law. A. SUCCESSFUL DEFENCES TO TAX EVASION CHARGES There are certain defences a taxpayer can successfully employ against a charge of wilful tax evasion. (i) LACK OF REQUIRED INTENTION (MENS REA) Since a finding of wilful tax evasion requires the Crown to prove deliberate intention on the part of taxpayer, a common defence against charges of tax evasion is to assert that the taxpayer did not actually possess the intention required for such an offence. Courts have indicated that the guilty mind requirement (i.e. mens rea) will not be met if it can be proven that a taxpayer only exhibited carelessness or recklessness without knowledge of the facts constituting the offence. Case law has indicated that the Courts, in deciding on whether the taxpayer possessed the requisite intent to be convicted of tax evasion, will consider a variety of factors including the taxpayer's level of intellect, general business knowledge, and previous experiences with tax authorities. 1. The Queen v. Dipasquale, 93 DTC 5389 In this Ontario Court General Division case, the taxpayer was a successful medical doctor, who was charged with wilful tax evasion pursuant to subparagraph 239(1)(d) of the Act. Specifically, the taxpayer was charged for failing to declare a threeyear span of income which amounted to approximately $300,000. The Crown alleged that these monies represented unreported income from the taxpayer's medical practice, 1

2 specifically from his dispensing of medication, as evidenced by unreported bank deposits. The lower court found the taxpayer guilty of wilful tax evasion stating that it was very unlikely that a taxpayer would simply overlook such a large amount of unreported income, suggesting the offence must have been wilful. The taxpayer appealed the lower Court's finding, arguing that he did not possess the deliberate intention required for the offence of wilful tax evasion. The taxpayer provided evidence that he was not wilfully blind, but instead merely careless given that due to his general inattention he submitted an erroneous tax return which actually required him to pay more taxes than he should have, as he also failed to report certain losses. The Ontario Court (General Division) found that the taxpayer was careless, but not deliberate or wilfully blind as the evidence indicated that if the taxpayer computed his tax return correctly he would have paid less taxes than he did under the erroneous tax return. As such, the Court found that the taxpayer did not have the requisite intent for the offence of tax evasion. Thus, if a taxpayer is able to prove he was only careless or reckless in the making of an erroneous tax return, but did not have deliberate intention to deceive or was not wilfully blind to the errors, the taxpayer will not be found guilty of tax evasion. 2. The Queen v. Cao, 92 DTC 6237 In this Manitoba Provincial Court case, the taxpayer was charged with evading taxes pursuant to subparagraphs 239(1)(a) and (d) respectively. The Crown alleged that the taxpayer, who was a recent immigrant from Malaysia and employed as a housekeeper, failed to disclose certain income he had earned. The Crown claimed that the taxpayer had earned income from charging fees for the service of delivering monies to persons in Vietnam, and it was this income that the taxpayer wilfully omitted from three consecutive tax returns. The Crown further claimed that during the Minister's investigation, the taxpayer was not forthcoming with information and gave a number of conflicting explanations for his actions. The taxpayer, in his defence, claimed that he did not operate such a business, rather it was his sister in Paris who did and he was simply helping her for no remuneration. The taxpayer attacked the Minister's estimation of his income, providing corroborated testimonial evidence indicating that his wealth, which the Minister claimed was attributed to income the taxpayer had earned, was actually attributed to the rather substantial family fortune his father had amassed. He also asserted that he gave the Minister conflicting explanations, as the (i) taxpayer's history of dealings with a 2

3 totalitarian regime made him extremely vulnerable to intimidation by the Minister and (ii) the taxpayer was a relatively unsophisticated man who kept very poor business records. The Court found the taxpayer was not guilty of tax evasion. The Court came to this conclusion on the basis that: (i) that the Crown failed to prove, beyond a reasonable doubt, that the taxpayer's wealth was actually attributed to unreported income; and (ii) even if the taxpayer had actually earned such income, the evidence indicated that the taxpayer did not have the intent to evade taxes as he lacked fluency in English, his previous experiences with a totalitarian regime led him to say things he thought the Minister wanted to hear, and he was an unsophisticated man with limited business knowledge. 3. R. v. Templeman, 2006 DTC 6374 In this Ontario Court of Justice case, the taxpayer was a very successful and busy real estate broker who was formally an employee at a real estate broker and became self-employed as an independent contractor providing services to the same real estate broker. He was selected for an audit for the 1998 and 1999 taxation years. Civil penalties were recommended and his file was later referred for investigation by the CRA. As a result of this investigation, the taxpayer was charged with tax evasion for the 1997, 1998 and 1999 taxation years. The taxpayer s returns were prepared by professionals however they used the figures and documents that had been provided to them by the taxpayer. These included thousands of receipts and invoices for personal and business expenses, which had been sorted and categorized by the taxpayer s assistant. The CRA auditors did not agree with all of the expenses claimed and these deductions were disallowed. The taxpayer was charged with tax evasion. The taxpayer in his defence argued that: (i) he relied upon his assistant to recognize and sort the business expenses into appropriate categories, since she was familiar with the business; (ii) the taxpayer did not ask his assistant to claim personal items as business expenses, but instead had provided her with the expense categories given to him by his accountants; (iii) the confusion arose because the tax years under investigation were the years he went from being an employee, who did not need to keep track of expenses, to being an independent salesman where such records were needed; (iv) the task of organizing the receipts was enormous and many personal receipts were likely to have been included accidentally; and (v) that items identified by the CRA auditors as personal could have also been business expenses. The taxpayer claimed that he may have been careless or negligent but this did not amount to criminal intent. 3

4 The CRA claimed the taxpayer: (i) knowingly permitted personal expenses to be included as business expenses, reducing his taxable income and leading to the evasion of taxes; and (ii) was wilfully blind to the inclusion of these personal expenses and should be held criminally responsible. The Court held that the taxpayer was not guilty of tax evasion. He was not wilfully blind and did not knowingly include personal expenses as business deductions. His assistant was responsible for sorting the thousands of receipts. The Court held that the taxpayer was engaged in a busy and high volume real estate practice, and it was not unreasonable for the very busy taxpayer to rely upon his assistant, given his focus on the sales and not the administrative aspect of the business. The Crown had not discharged its evidentiary burden of proving the elements of the offence beyond a reasonable doubt. 4. R. v. Hills, [2007] N.S.J. No. 234 The taxpayer earned professional income from his dental practice and other income from an investment portfolio ostensibly managed by his brother. Over the period of several years, the taxpayer's brother allocated to the taxpayer his own losses and income from his trading company, even though the taxpayer had no involvement with this company and consequently earned no income nor suffered any losses concerning any trading activities conducted by the company. When the taxpayer needed to pay taxes, his brother would go through the company's trading activities statement, selectively pick trades to arrive at the amount of loss that the taxpayer required, and then allocate them to him as if they were the taxpayer's actual trades. The following year, he would similarly allocate to the taxpayer the same amount in profits. These allocations affected the tax liabilities of both the taxpayer and his brother in such a way that all taxes would eventually be paid but not in the actual year when the tax liability would have occurred. The Minister charged the taxpayer with filing false tax statements and wilfully evading the payment of taxes. The Nova Scotia Provincial Court found the taxpayer guilty of filing false and deceptive statements, holding that he must have known that the amounts in question were not his trades but that they belonged to his brother. However, the Court found the taxpayer not guilty of tax evasion. The brother did not think that he was breaking the law and advised the taxpayer, who relied upon him, that it was proper to use these allocations to manage his tax account. The trades themselves were genuine and legitimate, and the brother testified that he had assured the taxpayer that it was proper to use these losses as a form of tax deferral. The court found that because the evidence 4

5 suggested that the taxpayer was depressing his income merely in order to delay the payment of taxes when due, the Crown failed to prove that the taxpayer intentionally avoided payment. 5. Penner et al. v. The Queen, 2010 DTC 5086 In this Provincial Court of Manitoba case, the taxpayer was accused of tax evasion. During a routine audit by the CRA, mistakes were discovered with regards to income earned by the taxpayer, losses claimed by the taxpayer s corporation, and GST credits claimed. Upon discovery of the mistake, the taxpayer co-operated fully with the CRA, and paid taxes, penalties and interest amounting to $40,000. The income involved only amounted to around $53,000. The Provincial Court of Manitoba held that the taxpayer was not guilty of tax evasion. In order to declare the taxpayer guilty of tax evasion, the Crown must not only prove that the taxpayer evaded paying tax, but also that he intended to evade taxes. In this case, there was no cover up of the income, and nothing was hidden from the auditor. Although the taxpayer took an active role in the activities of his business, he relied entirely on his bookkeeper and accountant for the disclosures required on a tax return. Additionally, as a carpenter with a grade 10 education, the taxpayer might have understood how to estimate job costs in order to make a profit, but accounting principles and tax law were beyond his expertise. The taxpayer took responsibility for the mistake made by his accountants, but the admission of an error does not necessarily amount to criminal tax evasion. The taxpayer exhibited the oversight one would expect from an individual in his position and with his background. (ii) RELIANCE ON A TAX PREPARING PROFESSIONAL Another defence against charges of tax evasion is to assert that the taxpayer relied on a tax professional to prepare the faulty tax return and had no knowledge of the facts constituting the offence, and as such, had no intent to evade taxes. Courts have indicated that the intention requirement for tax evasion will not be met if it can be proven that the taxpayer did not have the intention of acquiescing to a faulty return. In general, the Courts will find that there was a lack of intention on the part of the taxpayer to evade taxes if the taxpayer (i) only exhibited negligence by relying heavily on a tax-preparing professional, or (ii) negligently failed to identify an error in the tax return. 5

6 1. Regina v. Metke, 76 DTC 6313 In this leading Provincial Court of Alberta case, the taxpayer was a successful dairy farmer who was charged with tax evasion pursuant to paragraph 239(1)(d) of the Act for wilfully evading the payment of taxes during a four year period. The Crown claimed that the taxpayer erroneously computed his tax returns for these years. Specifically, the Crown argued that monies that the taxpayer had loaned (and collected back with interest) were erroneously recorded as a business expense, resulting in a substantial understatement of income for these years. The taxpayer claimed that he did not have the necessary intention for the offence of tax evasion. The taxpayer indicated that he had minimal knowledge of accounting procedures by producing evidence that he had a very basic system of bookkeeping, which consisted of keeping his financial information in Kleenex boxes. The taxpayer argued that as a result of his minimal accounting knowledge, he relied heavily on his accountant for the preparation of his tax returns. His accounting firm corroborated the taxpayer's dependency upon them. The Court was satisfied that the taxpayer, due to his rudimentary knowledge of accounting, would not have been able to identify the errors and as such relied heavily on his accountant to correctly prepare his tax returns. The Court found that while the taxpayer may have been negligent in depending so heavily on another person, the taxpayer did not have the intent required to commit tax evasion. As such, the Court found the taxpayer not guilty of tax evasion. (iii) IMPROPERLY OBTAINED EVIDENCE Section of the Act confers upon the Minister and the CRA broad audit and examination powers. Under subsection 231.1(1), an authorized person is permitted to: (i) (ii) inspect, audit or examine the taxpayer s books, records and documents and any document of any other person that may related to the information that is or should be in the books or records of the taxpayer; examine the taxpayer s inventory and anything else which may assist in determining the accuracy of that inventory; 6

7 (iii) (iv) enter any business premises where books or records are kept or should be kept. If the premises are a dwelling-house, a warrant must be obtained pursuant to subsection 231(1)(2); and require the owner, manager or any other person on the premises to give him all reasonable assistance and answer proper questions related to the administration and enforcement of the Act. A tax audit is an administrative process that does not trigger a taxpayer s rights pursuant to the Canadian Charter of Rights and Freedoms ( The Charter ). An investigation however is an adversarial and criminal process which invokes a person s right against self-incrimination. The provisions of the Charter must be considered when tax evasion charges are being investigated by the CRA Investigations Branch due to the threat of imprisonment. As a result, the Minister can no longer use the inspection and requirement powers pursuant to section of the Act to compel the production of documents, and must rely instead upon documents obtained pursuant to a search warrant. CRA investigators however can avail themselves of audit information obtained prior to the commencement of the criminal investigation. A taxpayer may be able to challenge tax evasion charges on the basis that the evidence was improperly obtained as evidence for a criminal investigation under the guise of a civil audit. 1. R. v. Jarvis, 2006 DTC 6477 In this Alberta Provincial Court case, which was also the taxpayer s second trial, the taxpayer was charged with tax evasion and making false or deceptive statements in his 1990 and 1991 tax returns. The taxpayer s wife was an artist who was deceased. The taxpayer was able to continue selling her art after her death. The auditor attempted to contact the taxpayer but when she was unsuccessful she contacted third-party sources such as art galleries in order to obtain records pertaining to art sales. When the taxpayer s accountant contacted the auditor, he notified her that the file was in disarray because of the taxpayer s poor record-keeping skills, and his general apathetic attitude towards financial and taxation matters since his wife s death. After meeting with the taxpayer and obtaining many of his records in April 1994, the auditor determined there was a discrepancy of approximately $700,000 between what was reported on the taxpayer s 1990 and 1991 tax returns and his actual income over the two years. The auditor referred the file to the CRA Investigations Branch ( Investigations ) in May 1994, but did not notify the taxpayer of the change in status, 7

8 even after inquiries by the taxpayer s accountant. The investigator was able to obtain a search warrant in November 1994 based on the information obtained from the April 1994 meeting, and a search was conducted. Documents found during the CRA search were seized and tendered as evidence during the taxpayer s first criminal trial in This evidence was challenged by the taxpayer during his 1997 criminal trial in the Provincial Court of Alberta on the grounds that it had been unlawfully obtained. The trial judge excluded all the evidence from the time the audit had become an investigation forward and acquitted the taxpayer. The Crown appealed to the Court of Queen s Bench of Alberta and a new trial was ordered. The taxpayer appealed the order for a new trial to the Court of Appeal of Alberta. His appeal was dismissed but he was granted leave to appeal to the Supreme Court of Canada in R. v. Jarvis, [2002] 3 SCR 757. The Supreme Court of Canada dismissed the taxpayer s appeal and upheld the Alberta Court of Appeal s judgment order for a new trial. The Supreme Court of Canada held that the warrant had been validly issued since an investigation had not yet been started in April The evidence obtained from the search under this warrant was admissible at the new trial. The Supreme Court held that any evidence obtained in connection with requirement letters issued by the CRA pursuant to subsection 231.2(1) of the Act after the investigation had commenced was to be excluded from the new trial, as the audit powers of the CRA were not to be used to further a criminal investigation. The Supreme Court concluded that when the predominant purpose of an inquiry is penal liability, the Minister must relinquish his audit powers under subsections 231.1(1) and 231.2(1) of the Act. At the taxpayer s second trial he was acquitted of tax evasion as he did not have the intent to willfully evade the payment of taxes and make false or deceptive statements on his 1990 and 1991 tax returns. 2. Stanfield v. M.N.R., 2005 DTC 5454 In this Federal Court case, the taxpayer filed an application for judicial review in respect of a request for audit information pursuant to section of the Act by the Minister contained in letters and questionnaires. The taxpayer opposed the Minister s request on the grounds that the request was not for audit purposes, but for a criminal investigation. The taxpayer was among a group of taxpayers who were audited for their 1998, 1999 and 2000 taxation year. One aspect of the audit was to determine the taxpayer s involvement with suspected tax shelters. In light of some evidence and development the CRA Audit Division (the Audit Division ) referred the file to the CRA Investigations Branch ( Investigations ) in April After the referral of the file, two auditors from the Audit Division kept in regular contact with Investigations, supplying information and 8

9 working closely with Investigations. In March 2002, Investigations allowed the Audit Division to recommence auditing the 1998 tax returns. The commodity losses claimed by the taxpayers were disallowed and civil penalties were levied pursuant to section 163(2) of the Act. The audits were restarted while the investigation was still on-going so that the reassessment would not become statute-barred because the provisions of subsection 152(3) and 152(4) of the Act allow for reassessments within three years of filing. Investigations then told the Audit Division to start auditing the 1999 and 2000 tax returns in July In order to solve the problem that the 1999 and 2000 tax returns would soon also be statute-barred, the request letters and questionnaires were sent by the Audit Division to the taxpayers between August to October The taxpayers were notified that while they were not currently under investigation, there was a criminal investigation for the promotion of the transaction type claimed on their tax returns. The taxpayers submitted that the predominant purpose of the request letters and questionnaires was to assist in a criminal investigation and these request letters and questionnaires should be declared invalid or unlawful pursuant to section 7 of the Charter. The Minister claimed that the taxpayers were not being criminally investigated when the audits were allowed to recommence. The Minister submitted that the questionnaires were needed in order to conduct a proper audit. The Federal Court held that the predominant purpose of the letters and questionnaires was to help with a criminal investigation. The Minister could not issue these letters under the audit powers of the Act. The taxpayers Charter rights were engaged and they had the right to remain silent and to avoid self-incrimination. The Federal Court found that the taxpayers were still under investigation when the 1998 reassessment notices were sent. The investigators were also still in possession of the taxpayers files as of June 2004; indeed the Audits and Investigations departments worked closely together for several months despite the supposed cessation of the investigation. Information flowed from the auditors to the investigators regularly. The Court also noted that the questionnaire appeared to inquire into a taxpayer s intent or mens rea, which would be important for a criminal investigation but not so much for assessing civil liability. 3. Borg v. The Queen, 2007 DTC 5671 In this Ontario Court of Justice decision, the CRA conducted a compliance audit of the taxpayer s business between April 1995 and March During the course of the audit, the Minister examined the taxpayer s books and records pursuant to the 9

10 auditing powers under the Act. Based on the compliance audit, the CRA conducted a criminal investigation and charged the taxpayer with tax evasion and making a false statement in his returns under the Income Tax Act and Excise Tax Act. During the criminal investigation, the CRA obtained bank records through a third party requirement for information. Prior to the commencement of the trial, the taxpayer applied for an order to exclude the evidence obtained during the civil audit. The taxpayer argued that gathering information during the civil audit for the predominant purpose of investigating a criminal offence was an improper exercise of the Minister s powers and a violation of the taxpayer s Charter rights. In addition, the taxpayer argued that the evidence gathered during the criminal investigation without a search warrant was a violation of the taxpayer s Charter rights and should not be admissible. The Court granted the taxpayer's application. As of May 1995, the predominant purpose of the compliance audit was to build a criminal case against the taxpayer for tax evasion or fraud. The evidence gathered after this time had to be excluded, as it was obtained in breach of the taxpayer s Charter rights. The evidence gathered through a third-party requirement during the criminal investigation also had to be excluded, as it was obtained or derived in breach of the taxpayer s Charter right to be secure against unreasonable search and seizure. B. UNSUCCESSFUL DEFENCES TO TAX EVASION CHARGES Case law has pointed out that there are a large number of defences against tax evasion which are generally unsuccessful. Such defences include assertions that the individual charged with wilful tax evasion (i) (ii) (iii) (iv) did not sign the tax return in question; experienced alcohol or marital problems during the years in question; generally exhibited disorganized and dilatory behaviour; was incapable of dealing with the payment of taxes; 10

11 (v) (vi) retained a person who was inexperienced in bookkeeping to be responsible for the taxpayer's books and records from which the erroneous tax return was made; and taxpayer believed that the federal government did not have the authority to collect taxes. The defence that the tax return under investigation is unsigned and as such is not a "tax return" within the meaning of the Act, is generally rejected by the Courts. In The Queen v. Kidd, 74 DTC 6574, the taxpayer was accused of wilfully evading taxes on the basis that he had deceitfully under-reported his income over several taxation years. In his defence, the taxpayer contended that his failure to sign the tax returns caused the documents to become something other than 'tax returns' and as a result he was not susceptible to evasion charges. The Ontario Superior Court held that the taxpayer could not rely on this defence as the tax return was complete and sufficient enough to illustrate that the taxpayer intended the return to form the basis of his tax assessment. The argument that an understatement of income or failure to file was a result of alcoholism or marital problems, is a defence that the Courts have generally not accepted. In The Queen v. Robson, 79 DTC 5198, the taxpayer, a successful farmer and university education businessman, was charged with wilful evasion of taxes on the grounds that he intentionally failed to disclose certain income. In his defence, the taxpayer claimed that his failure to disclose income was unintentional due to his excessive use of alcohol and marital problems. The Saskatchewan Provincial Court held that the taxpayer was guilty of tax evasion, finding that the taxpayer could not rely on this defence as despite the taxpayer's difficulties he was able to operate his farming and business operations. In Sturgess v. The Queen, 84 DTC 6525, the defence that the taxpayer had not intentionally evaded taxes, by virtue of the fact that the taxpayer was merely disorganized and dilatory, was clearly dismissed by the Court. In this case, the taxpayer who was charged with wilful tax evasion was a medical doctor who had filed a number of his tax returns only after the Minister demanded them. The taxpayer, in his defence stated that he did not intentionally attempt to evade taxes, rather his general disorganized and tardy nature led him to simply not file his tax returns on time. The Federal Court rejected such a defence stating that the evidence indicated that the taxpayer never would have filed his tax returns, nor have paid his taxes, had the Minister not insisted he file his returns. As such, the taxpayer was found guilty of tax evasion. 11

12 In R v. Wolf, 84 DTC 6033, the taxpayer was charged with wilfully evading taxes on the basis that he failed to file his tax returns for four consecutive years. The British Columbia Court of Appeal rejected the taxpayer's defence that only failed to file his tax returns because he was unable to pay his taxes, and would have filed his tax returns as soon as he was able to pay the taxes he owed. The Court found that taxpayer's defence was not sufficient to defend against the tax evasion charges, concluding that the taxpayer failed to file his tax returns in order to avoid alerting the authorities that he was not meeting his tax obligations - which fits the definition of tax evasion. In addition, the Courts have generally rejected the defence that an inexperienced person was responsible for keeping the taxpayer's books and records from which the erroneous tax returns were made. In The Queen v. Horowitz, 71 DTC 5350, the Court outright dismissed such a defence. In this case, the individual charged with tax evasion was an owner of a real estate agency. He argued that his wife's inexperience and carelessness in keeping his books and records caused the errors in his tax return that he had inadvertently failed to notice. The Court, dismissed this defence, and found the taxpayer guilty of tax evasion on the basis that the taxpayer was at the very least wilfully blind in entrusting such an inexperienced person to keep his books and failing to 'notice' large errors in the tax return. The Courts have been firm in rejecting challenges to the validity of the Act and the Federal Government s ability to impose and collect taxes, as well as in denying the availability of the natural person defence. The natural person defence provides that each person has two separate identities, a natural person and a legal entity. The taxpayer typically claims that his income has been earned as a natural human being who is not subject to the Act. No income has been earned by him in his capacity as a legal entity liable to pay income tax under the Act. In R. v. Loosdrecht, 2009 DTC 5131, the taxpayer was charged pursuant to paragraph 239(1)(a) and (d) of the Act for his 2001, 2002, 2003 and 2004 taxation years. The taxpayer was a real estate agent who earned income for the four years in question however listed his income on his tax returns as zero. The taxpayer claimed that the definition of person in the Act did not include him as a natural person. The Provincial Court of British Columbia held that the taxpayer s argument that the Act did not apply to the income he earned as a natural person, and not as a legal entity, had no basis. The case law was extensive and this defence has never been successful. Previously, the B.C. Court of Appeal held that the ordinary meaning of person is a natural person and the purpose of the statutory definition was to extend the meaning to include other legal entities. The taxpayer was found guilty of all counts of tax evasion 12

13 since the Crown had proven beyond a reasonable doubt the actus reus and the mens rea of the offences. This issue of the Legal Business Report is designed to provide information of a general nature only and is not intended to provide professional legal advice. The information contained in this Legal Business Report should not be acted upon without the further consultation with professional advisers. Please contact Howard Alpert directly at (416) if you require assistance with tax and estate planning matters, tax dispute resolution, tax litigation, corporate-commercial transactions or estate administration. No part of this publication may be reproduced by any means without the prior written permission of Alpert Law Firm Alpert Law Firm. All rights reserved. 13