Summary - Sarmadi v. Canada, 2017 FCA 131
In Sarmadi v. Canada, 2017 FCA 131, the appellant taxpayer appealed to the Federal Court of Appeal from the decision of the Tax Court of Canada to deny his appeal. Specifically, the taxpayer alleged that the Tax Court judge made a palpable and overriding error by rejecting evidence that the appellant’s father had loaned him a total of $90,000 during the 2003 and 2004 tax years, which, if accepted, would have reduced the amount of income assessed by CRA to the taxpayer’s 2003 and 2004 taxation years by $90,000.
Facts Sarmadi v. Canada
The taxpayer operated a taxi business and owned multiple rental properties during the 2003 and 2004 taxation years. During that period the taxpayer was also a full-time student. CRA undertook a tax audit of the taxpayer’s 2003 and 2004 personal tax returns. The CRA auditor determined that records provided by the taxpayer were inadequate and incomplete and proceeded to undertake a net worth tax audit of the taxpayer. Following the net worth tax audit, CRA issued notices of tax reassessment to the taxpayer for 2003 and 2004 that had the effect of greatly increasing the rental and business income figures reported by taxpayer.
On appeal to the Tax Court of Canada, the only issue before the Court was whether CRA had correctly concluded that the taxpayer’s father did not lend the taxpayer a total of $90,000 during the 2003 and 2004 taxation years. If the loans could be substantiated by the taxpayer, the taxpayer would be entitled to be reassessed by CRA to remove an aggregate of $90,000 in income from his 2003 and 2004 taxation years.
The Tax Court judge noted that CRA had made the assumption that the taxpayer had unreported rental and business income and that the taxpayer therefore had the onus of satisfying the Court that $90,000 of the amount assessed came from a non-taxable source, ie. a loan from his father. The burden of proof in Tax Court litigation is unique in that a pure assumption of fact made by CRA can form the basis of a tax assessment, which the taxpayer then has to challenge. In Hickman Motors Ltd. v Canada,  2 SCR 336, the Supreme Court held that the taxpayer has the initial onus of “demolishing” CRA’s assumptions, by establishing a prima facie case through the production of uncontradicted and unchallenged evidence. If the taxpayer establishes a prima facie case, the onus then shifts to CRA to prove its assumption on a balance of probabilities. In Samardi, this meant that the taxpayer was required to provide uncontradicted and unchallenged evidence of a bona fide loan made to him by father.
The Tax Court judge concluded that there was not sufficient or reliable evidence to substantiate the existence of the $90,000 loan to the taxpayer from his father. Because the alleged loans were undocumented and purportedly made in cash, the Court was forced to rely on the oral evidence of the taxpayer and his father. The Court found that the taxpayer’s evidence was self-serving, contradictory and that the taxpayer’s recollection of the circumstances surrounding the alleged loan had changed significantly at each of the tax audit, tax objection, examination for discovery and trial stages, discrepancies which the taxpayer was unable to explain on cross-examination. In particular, the Tax Court judge was skeptical of the fact that neither the taxpayer nor his father could definitively state when the taxpayer began borrowing money from his father, the reason(s) for the loan and how much had even been borrowed by the taxpayer. The Court held that the taxpayer had not provided any reliable evidence to counter CRA’s assumptions and dismissed the appeal.
Issues on Sarmadi v. Canada Appeal and Federal Court of Appeal Analysis
The Federal Court of Appeal only had one issue to consider on appeal: whether the Tax Court of Canada judge had made a palpable and overriding error in choosing to reject the taxpayer’s evidence to substantiate the $90,000 loan from his father. In support of the appeal, the taxpayer argued the following:
- CRA should not have utilized the net worth tax audit methodology of the taxpayer;
- Since there were no aggravating circumstances to justify CRA utilizing a net worth tax audit, the Tax Court judge should have accepted the taxpayer’s evidence regarding the $90,000 in loans;
- It is absurd for CRA to conclude that the taxpayer earned substantial income during a time in which he was a full-time student; and
- The Tax Court judge’s reasons were inadequate.
The Federal Court of Appeal had no difficulty dismissing each of the appellant taxpayer’s arguments for lack of merit. With respect to the taxpayer’s first point, Woods JA found that since the validity of the net worth assessment technique was not raised by the taxpayer at Tax Court, it could not be considered by the FCA on appeal. Regarding the appellant taxpayer’s second point, Woods JA held that the Tax Court judge simply found that the evidence of the taxpayer and his father was not reliable or credible which, as the trial judge, he was empowered to do. Woods JA determined that it was entirely possible for a full-time student to earn a substantial income and also noted that this finding was not at all inconsistent with the Tax Court Judge’s findings of credibility and reliability. Lastly, Woods JA was of the opinion that the Tax Court judge’s reasons were clear, detailed and “fit well within the standards established by jurisprudence”.
It should also be noted that Webb JA in obiter undertook an in-depth analysis of the case law relating to the burden of proof in tax cases, however both Woods JA and Stratas JA explicitly chose not to endorse the comments of Webb JA, instead choosing to leave the discussion to a future case where the burden of proof plays a more significant role.
Canadian Tax Lawyer Analysis of Samardi
The taxpayer’s appeal to the Federal Court of Appeal in Samardi faced several hurdles, chief of which were a lack of supporting documentation for the alleged $90,000 loan and inconsistent positions taken by the taxpayer during his dispute of CRA’s tax assessment, which lead to an adverse finding of reliability and credibility by the Tax Court judge. These deficiencies are inter-related: a lack of documentation meant the taxpayer in Samardi had to prove the existence of the loan relationship solely through oral testimony, which in turn put his credibility and reliability under the microscope.
In Samardi, not only was the alleged loan agreement not in writing, but neither the taxpayer nor his father could state when or why the funds were advanced, nor could they state how much was advanced each time. Throw in the fact that all payments made under the purported loan in Samardi were in cash, with no supporting documentation or journal entries provided as evidence, and it is not surprising the tax dispute ended up in court.
When supporting documentation is not available to substantiate the existence of an agreement or transaction, taxpayers can provide oral evidence to the Tax Court of Canada to prove the existence thereof. In Benjamin v The Queen, 2006 TCC 69, Chief Justice Bowman accepted a taxpayer’s oral testimony as proof that the taxpayer had in fact made an otherwise undocumented loan to his corporation on the basis that the taxpayer’s oral evidence was credible. However, “credible” is the operative word and the Tax Court judge is not obliged to believe a taxpayer’s version of events, particular if it is evasive, inconsistent, contradictory and/or self-serving. It is also important to note that it is widely accepted in all areas of law that the assessment of a particular witness’s credibility falls within the exclusive jurisdiction of the trial judge, who will generally have had the opportunity to observe a witness’s testimony and general conduct in person and in real-time. Appellate courts are loath to interfere with findings of credibility made by a trial judge.
In Samardi, the Tax Court judge focused on the inconsistent positions the taxpayer had taken throughout his dispute of the tax assessment as proof that his testimony was unreliable. Specifically, at trial the taxpayer testified that his father received $90,000 in cash from the sale of his principal residence and placed all of the cash in a heavy safe. However, at examinations for discovery, the taxpayer, under an affirmation to speak the truth, stated that his father invested the $90,000 cash proceeds in GICs. In addition, at the objection stage the taxpayer asserted that he used the funds advanced to him by his father to pay off his credit card. At examinations for discovery, the taxpayer instead stated that he used the loan from his father to buy a specific property. At trial, the taxpayer testified that he used the loan proceeds to purchase two properties, renovate each and turn one into a denture clinic. These are just some of the many inconsistencies the Tax Court judge relied on in concluding that the taxpayer’s testimony was not reliable. We are not suggesting that the taxpayer was lying, but his inconsistent statement of the facts throughout his tax dispute, and in particular his apparent inability to satisfactorily explain these inconsistencies, severely undermined his credibility and reliability as a witness in the eyes of the Tax Court. The Tax Court judge’s findings on reliability were the preeminent reason for the Court declining to accept the taxpayer’s evidence of the $90,000 loan. This, in turn, significantly undermined the taxpayer’s chances on appeal because, as noted above, the Federal Court of Appeal will not interfere with a Tax Court judge’s findings of credibility and/or reliability lightly, and the taxpayer’s appeal in Samardi essentially involved him arguing that the Tax Court judge should have accepted the taxpayer’s evidence, ie. the judge should not have concluded that the taxpayer’s evidence was unreliable and incredible.
Tax Tips – Lessons from Samardi
Having a Canadian tax lawyer prepare proper documentation to support transactions or agreements is an essential component of successfully withstanding a CRA tax audit. Claiming the existence of a transaction or agreement by oral means alone is a road that inevitably leads to expensive Tax Court litigation. CRA tax auditors require documentation to establish facts and will rarely, if ever, accept a taxpayer’s own assertion that a particular transaction or agreement took place, particularly if the existence of either would be beneficial to the taxpayer. While CRA appeals officers have more discretion than tax auditors, they are still going to want to see something to substantiate the transaction or agreement, such as cancelled cheques or bank statements that corroborate payments allegedly made or received by a taxpayer. In addition, it is important to not underestimate the benefits of having an experienced Canadian tax lawyer involved in your tax assessment dispute from the beginning, who can help identify an appropriate strategy for your tax dispute, which should be maintained throughout the tax litigation process and avoid inconsistent positions.