Hot Spot Restaurant Inc. v. R. – TCC: Tax Court throws out net worth assessments and penalties against five taxpayers

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Hot Spot Restaurant Inc. V. The Queen (October 27, 2014 – 2014 TCC 318) was an appeal from net worth assessments arising out of a prior tax evasion case:

[7] Hot Spot operates a restaurant/sports bar (the “Restaurant”) in Regina. The Restaurant is located above a bowling alley.

[8] The shareholdings of Hot Spot are as follows:

• Mia [Weinkauf] – 30%

• Mia’s sister and brother-in-law – 40%

• Voula [Danakas] – 30%

[9] Voula testified that she holds the Hot Spot shares for her son John, who has a disability. During the relevant period, Voula and Mia were the directors of Hot Spot.

[10] Notwithstanding the shareholdings of Hot Spot and the fact that Voula and Mia were the only directors of the corporation, it is clear from the evidence before me that Peter [Danakas] was the directing and controlling mind of Hot Spot. He made all financial, management and business decisions with respect to the corporation and the operation of the Restaurant.

[14] On October 9, 2002, the CRA conducted a search and made a seizure of documents at the premises of Hot Spot, the homes of the Individual Appellants and the office of Mr. Szysky. Mr. Dreger testified that the CRA obtained nearly all of the books and records of Hot Spot during the search and seizure. He stated: “There was very few missing records.”

[15] The Appellants were reassessed under the Income Tax Act in September and October 2003 (the “First Reassessments”). Also, in October 2003, the Crown laid criminal charges for evasion of income taxes against Hot Spot and the Individual Appellants. Mr. Dreger then took over the CRA investigation.

[16] In 2004, Mr. Dreger made a determination of the income of Hot Spot and the Individual Appellants.

[17] The parties reached a plea bargain with respect to the criminal charges. On April 18, 2006, a criminal conviction was entered against Hot Spot. The Crown stayed the charges against the Individual Appellants.

[18] On October 5, 2006 the documents obtained by the CRA during the 2002 search and seizure were returned to the Individual Appellants and Hot Spot. The CRA returned Mr. Szysky’s files on August 21, 2007.

[19] The CRA reassessed Peter Danakas on October 3, 2003, Hot Spot on February 14, 2008 and the three surviving Individual Appellants on March 18, 2008 (the “Second Reassessments”).

[20] The Minister reassessed Voula and Mia in respect of their 1997, 1998 and 1999 taxation years and Peter and Jason in respect of their 1998 and 1999 taxation years. The Minister based the Second Reassessments of the Individual Appellants on net worth calculations prepared by Mr. Dreger. The Minister determined that collectively the four Individual Appellants had failed to declare income of over $380,000 on their income tax returns. As I will discuss, she allocated most of this purported income to Voula and Mia.

[21] The Minister also assessed Hot Spot for unreported income for its taxation year ending on March 31, 1998 (the “1998 taxation year”) and its taxation year ending on March 31, 1999 (the “1999 taxation year”). This unreported income exceeded $340,000. The CRA did not perform a net worth calculation for Hot Spot. Mr. Dreger used the seized books and records of Hot Spot to determine the taxable income of Hot Spot.

[22] The Appellants disagree with the reassessments. They argued that, after being closed for seven months due to the fire, the Restaurant did not return to profitability until its 2000 taxation year. They argued that any increase in net worth that occurred prior to 2000 was a result of loans from family members and friends, distributions from an estate, and significant payments under two insurance claims.

[23]        Counsel for the Respondent informed the Court, at the commencement of the hearing, that the Respondent did not feel that either res judicata or issue estoppel applied in respect of the criminal conviction of Hot Spot. After reviewing the transcript of the sentencing proceedings, I agree with the Respondent.

[24]        Hot Spot’s conviction was based on a settlement and has no bearing on these appeals. The Appellant’s counsel stated during the sentencing proceedings that Hot Spot found the amount of the alleged unreported income to be absurd. He suggested that the plea agreement avoided the cost of a long trial and allowed for the dropping of the charges against the Individual Appellants.

[Footnotes omitted]

Peter Danakas passed away in 2005.

This decision is a very rare example of taxpayer being completely vindicated after a prior guilty plea bargain in a tax evasion prosecution. The court goes through each aspect of the Crown’s case with meticulous precision and, not to put too fine a point on it, eviscerates it. The only aspect of the net worth assessments against the appellants that survives is $4,314 which Voula Danakas failed to report in 1998. All of the other assessments against all of the appellants for all the years under appeal were struck. All of the gross negligence penalties against all of the appellants for all of the taxation years under appeal were struck.

While this decision is too detailed to blog in full I highly commend it to my readers as a textbook example of how to successfully attack net worth assessments.