This issue of the Legal Business Report provides current information to the clients of Alpert Law Firm on penalties 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 and estate planning matters, tax dispute resolution, tax litigation, corporate-commercial transactions and estate administration. Howard Alpert, C.S. is certified by the Law Society as a specialist in Corporate and Commercial Law and as a specialist in Estates and Trusts Law.
A. SUBSECTION 163(2) PENALTIES
Pursuant to the provisions of subsection 163(2) of the Income Tax Act (the "Act"), the Minister of National Revenue (the "Minister") may impose penalties on taxpayers who knowingly or under circumstances amounting to gross negligence make, participate in, assent to, or acquiesce in the making of a false statement or omission in a tax return, form, certificate, statement or answer filed or made in respect to a taxation year.
It is important to note, that the imposition of such a penalty requires either one of the following constituent elements to be proven: (i) the taxpayer had knowledge of the omission or false statement; or (ii) the taxpayer was grossly negligent in regards to the omission or false statement.
Pursuant to subsection 163(3) of the Act, the Minister has the onus of proving, on a balance of probabilities, the facts indicate that either of these elements exist. If the Minister fails to establish that the facts of the case justify the assessment of the penalty, then the penalty cannot be imposed. While the Minister has the burden of justifying the imposition of the penalty, the taxpayer still has the usual burden of challenging the Minister's assessment.
The penalties imposed under subsection 163(2) can be substantial. The taxpayer will be liable for a penalty of the greater of $100 and 50% of the tax payable on the taxpayer's understatement of income (i.e. 50% of the amount by which the tax that would have been payable by the taxpayer if the false statement had not been made in the taxation year exceeds the amount of tax which would have been payable if the return was accepted as filed).
In addition, pursuant to subsection 163(1) of the Act, the Minister may impose penalties on taxpayers who repeatedly fail to report income in their tax returns. The penalty under subsection 163(1) is 10% of the amount which was not reported in the tax return. Under this penalty there is no requirement for the Minister to prove intent or negligence on the part of the re-offending taxpayer.
Also, a taxpayer who entirely fails to file a tax return, or files a tax return after the required time, can be subject to a penalty of 5% of the unpaid tax, pursuant to subsection 162(1) of the Act. There is also a similar penalty for repeated failures to file a tax return pursuant to subsection 162(2) of the Act.
The taxpayer could also be charged criminally with income tax evasion pursuant to the provisions of subsection 239(1) of the Act. However, a person who is criminally convicted under subsection 239(1) cannot be held liable to pay a penalty imposed under sections 162 or 163 for the same evasion, unless the person was assessed for that penalty under section 162 or 163 before the information or complaint giving rise to the criminal conviction was laid or made.
If the Department of Justice decides to prosecute a taxpayer for tax evasion, it can elect to proceed summarily or by indictment. Subsection 239(1) of the Act states that upon summary conviction for tax evasion, fines ranging from 50% to 200% of the amount sought to be evaded could be levied, as well as a possible imprisonment term of not more than two years. If the Department of Justice elects to proceed by indictment, upon conviction the offending taxpayer could pay fines ranging from 100% to 200% of the amount sought to be evaded, as well as face a maximum imprisonment term of five years, pursuant to subsection 239(2) of the Act.
In addition, third parties who advise or participate in the making of a false statement or omission in a tax return can also be held liable for civil penalties, pursuant to the provisions of subsection 163.2 of the Act. However, these penalties are limited to persons who either: (i) knew such statements or omissions were false; or (ii) should be reasonably expected to know that such statements or omissions were false.
B. DEFENCES AGAINST IMPOSITION OF PENALTIES
Where penalties under subsection 163(2) of the Act have been assessed, the Minister has the burden of justifying their imposition. The Minister must prove, on a balance of probabilities, that the taxpayer had knowledge of, or exhibited gross negligence in the making of, the false statement or omission. An attack upon any of these constituent elements amounts to a defence against the imposition of penalties.
(i) RELIANCE ON PROFESSIONAL ADVICE
Penalties under subsection 163(2) of the Act can be challenged by the taxpayer on the basis that the taxpayer relied upon the professional services of an accountant to prepare the income tax return, and as such the taxpayer did not have knowledge of, or was not grossly negligent in the making of, the false statement or omission.
In general, the Courts have said that where errors or omissions have been made in a tax return and there has been gross negligence on the part of the accountant who prepared the tax return, the accountant's gross negligence cannot be automatically attributed to the taxpayer. Rather, it is up to the Minister to prove that the taxpayer is indeed liable for the accountant's gross negligence by proving either that the taxpayer had knowledge of the mistakes, or that the taxpayer was grossly negligent himself for failing to notice the accountant's mistakes.
To ascertain whether the taxpayer's reliance on professional advice provides an adequate defence against the imposition of penalties, the Courts look at a variety of factors, including:
(i) whether the taxpayer was actually privy to the omission or error of the accountant;
(ii) the taxpayer's level of participation in the preparation of the tax return by the accountant;
(iii) the taxpayer's business expertise or knowledge of income tax and accounting principles that would have made it likely that the taxpayer actually knew of the errors or omissions made by the accountant;
(iv) whether the taxpayer had reason to believe that the accountant would make errors or omissions in the tax return (i.e. the qualifications and experience of the accountant; the duration of the taxpayer's reliance on professional advice without any income tax problems arising); and
(v) whether the amount of the error or omission was such that the taxpayer would have reasonably been aware of it.
(ii) MATERIALITY OF UNREPORTED INCOME
Where the Minister assesses penalties on the basis of gross negligence, a taxpayer can raise the defence that the size of the unreported amount was not substantial or material given the facts of the case. Case law has indicated when evaluating this defence, the Courts may take into account facts which indicate: (i) sizeable complexity of the taxpayer's business transactions; and (ii) the overall size of the unreported income is inconsequential given the taxpayer's total taxable income.
The Courts have also cancelled penalties where the discrepancy between the Minister's net worth assessment and the taxpayer's own figures are judged to not be significantly different. The Courts have also found the net worth assessment method to be imprecise and the taxpayer may be given the benefit of the doubt in the above mentioned circumstances.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.