Four Tax Fraud Cases Involving Fiscal Arbitrators Released
Four judgments on cases involving tax fraud through false statements on tax returns have recently been released. Each case is an appeal of the assessment of a gross negligence penalty by the Canadian Revenue Agency ("CRA") against the taxpayer. In all cases, the taxpayer used a tax preparer from Fiscal Arbitrators or a tax preparer associated with Fiscal Arbitrators to prepare their returns. All returns were later found to contain blatant misstatements. Despite the obviously false statements contained in their returns, in three cases, the taxpayers won and the gross negligence penalties were deleted. In the final case, the gross negligence penalty was upheld. This Canadian tax law firm article will summarize the facts of each case and highlight factors that may lead to success or failure in gross negligence penalty appeals and, in particular, what is necessary to eliminate penalties related to Fiscal Arbitrators and DSC Lifestyle Services.
Canadian Gross Negligence Penalties
The income tax system in Canada is both self-reporting and self-assessing. As such, it relies on the honesty and integrity of taxpayers in order to function effectively. Taxpayers have a duty to report their taxable income completely and correctly, regardless of who prepares the return, as the success of the Canadian income tax system is dependant on taxpayer compliance and truthfulness. In order to induce taxpayers to disclose their income, and to penalize the ones who don't, CRA conducts tax audits and the Income Tax Act (the "Act") allows the CRA to assess penalties for failure to file under section 162 and to assess penalties for false statements under section 163. The penalty provisions under the act, especially the gross negligence penalties for misstatements, are quite serious since they amount to tax fraud. We recommend that you consult our experienced Canadian tax lawyers if you have been assessed penalties under section 162 or section 163 of the Tax Act.
Under section 162(1), the failure to file penalty is calculated in two parts. First, 5% of tax payable that was unpaid when the return was required to be filed is assessed. Second, 1% of unpaid tax payable is multiplied by the number of complete months that pass between the required dated of filing and the actual date of filing (up to a maximum of 12 months). Under the repeated failure to file penalty in section 162(2), the percentages are doubled to 10% and 2% respectively and the number of months that the penalty can be applied to increase to 20 from 12. Under section 163(2), a misstatement penalty is often assessed at the greater of $100 or 50% of the amount of tax that was avoided as a result of the misstatement.
Fiscal Arbitrators & DSC Lifestyle Services
The modus operandi of Fiscal Arbitrators was to entice taxpayers with the promise of a large refund. In exchange, Fiscal Arbitrators would charge a fixed fee for the preparation of the return in addition to a percentage of any refund obtained. Fiscal Arbitrators generated the refunds by claiming fabricated business losses and using carry back rules to refund taxes previously paid by the taxpayer. DSC Lifestyles Services was also involved in the scheme and would refer their clients to Fiscal Arbitrators for a cut of proceeds. According to reports on CTV'S W5, as many as 1,800 Canadian were involved in the Fiscal Arbitrators program.
Fiscal Arbitrators Gross Negligence Penalties Cases Fact Summaries:
In all of the cases below, the taxpayer committed tax fraud by falsely claiming a large fictitious business loss as per the advice of Fiscal Arbitrators which, if allowed, would result in a refund to the taxpayer of taxes withheld at source for the year filed. In addition, the taxpayer also signed a "Request of Loss Carryback" to apply the business loss to prior taxation years. All of the taxpayers were assessed gross negligence penalties. In no cases did they consult with a Canadian tax lawyer before submitting their returns.
Anderson & The Queen [2016 TCC 93]("Anderson"): In 2008, the taxpayer claimed a business loss even though his only income was from employment. The taxpayer was born in 1955, was unmarried, was without children, and dropped out of school at the age of 15. The taxpayer worked odd jobs until he was employed at Canada Pacific Railway ("CPR") where he worked for 36 years. The taxpayer had no tax or accounting education. The taxpayer had never prepared a tax return himself. His mother, tax preparer's and friends had helped him file up until the 2008 taxation year. In 2008, the year at issue, the taxpayer had his return prepared by Mr. Muntaz Rasool. The taxpayer met Rasool through a co-worker in 2006. Rasool would frequently promote programs to employees of CPR which would generate refunds for the filers. The taxpayer believed that Rasool was an experienced person in tax matters since others at CPR had dealt with him without issue. Rasool was also able to produce credentials such as reference letters as well as a business card stipulating that he had an accounting designation. The taxpayer invested in programs endorsed by Rasool in 2006 and 2007 and received refunds. In 2008, the taxpayer hired Rasool to prepare his return. The taxpayer was presented his return and signed were indicated but, he inquired about why the refund was so large. Rasool's rationale was that he had special knowledge of the Act. At trial, the Taxpayer testified that he word "per" in front of his signatures, which was included on the filed return, had been added without his knowledge and that certain pages regarding the business loss and loss carryback were also added. When reviewing his return, the taxpayer did notice that the tax preparer box was blank and added Rasool's information. This upset Rasool. The taxpayer paid Rasool a portion of the refund he received. The taxpayer requested a copy of the return from Rasool and was refused. The taxpayer was later contacted by the CRA for a tax audit regarding the alleged business that had produced the loss. The taxpayer provided the correspondence from the CRA to Rasool who later disappeared. The taxpayer did not send any letters drafted by Fiscal Arbitrators to the CRA.
Morrison & The Queen [2016 TCC 99 ]("Morrison"): The CRA assessed a tax penalty against the taxpayer for the 2008 taxation year for his tax fraud. The taxpayer was from a small town. The taxpayer was put into contact with a tax preparer through a friend whom he had known for over 30 years. His friend had received a substantial refund without issue. The taxpayer was a car salesman and had filed his own returns for 40 years. The tax preparer presented him with a T1 adjustment and the taxpayer signed where indicated. Pages were later added to the return after it was signed. The T1 adjustment did reference a "business loss;" however, the taxpayer only turned his mind to the fact that if he overpaid tax for 5 years and was refunded for all those amounts, a substantial refund could be produced. The CRA conducted a tax audit inquiring about the business loss. The taxpayer contacted his preparer and the preparer responded with a "nonsensical" letter which the taxpayer refused to sign. The taxpayer then filed a Notice of Objection. The taxpayer cooperated with the appropriate investigative division.
Sam & The Queen [2016 TCC 98 ]("Sam"): The taxpayer had her returns prepared for many years by her sister-in-law Denise Hunt. Denise had a university background in accounting and the taxpayer had received refunds for many years due to the deduction of union fees and RRSP contributions. Denise worked for an accounting corporation named DSC for six years until her death in 2010. The taxpayer went to the DSC office in order to have her 2009 return prepared. The taxpayer was referred to Fiscal Arbitrators. When the taxpayer inquired as to the identity of that individual, she was told not to worry as the person had done thousands of returns. The completed return was delivered back to DSC for the taxpayer to sign. The taxpayer looked at the return briefly and signed the return and the loss carry back form. When the refund did not arrive the taxpayer was referred to Larry Watts of Fiscal Arbitrators who provided her with "nonsensical" letters to send to the CRA. The taxpayer sent the letters. The taxpayer believed she was getting valid advice. The taxpayer was not pitched to specifically hire Larry or Fiscal Arbitrators for the purposes of obtaining a refund.
Sledge & The Queen [2016 TCC 100 ]("Sledge"): The Taxpayer was 45 years old, was born in Texas, and does not have any post secondary education. The taxpayer is a former US Navy sailor and was subsequently employed in Canada as an Operations Manager for FedEx. Ten years prior to the appeal the taxpayer met Lloyd at a barbershop. The taxpayer does not know Lloyd's last name. The two became friends and spoke about income taxes. Prior to 2008, the taxpayer had his return prepared at H&R Block. Lloyd told the taxpayer about a company called Fiscal Arbitrators. Fiscal Arbitrators represented themselves as professional tax preparers. They would recalculate taxes over a 10 year period in order to obtain a refund for taxes overpaid in previous years. The taxpayer met Lloyd's sister who endorsed the company. The taxpayer was still concerned about legality, but Lloyd assured him they were just like H&R Block. The taxpayer retained Fiscal Arbitrators and provided Lloyd with his T4's for the previous ten years. Once prepared, the taxpayer did not review his return and simply signed where indicated. The taxpayer did not see that the identification box for tax preparers was left blank. The taxpayer testified that he did not look at the numbers on his return and also testified that he did not look at the refund amount he was claiming. The taxpayer did not ask any question regarding the contents of the return. The CRA later contacted the taxpayer in a tax audit questioning the business loss. The taxpayer contacted Lloyd. The taxpayer was referred to Larry Watts from Fiscal Arbitrators who provided the taxpayer with nonsensical letters to send to the CRA. The taxpayer later reached out to the CRA as the letters drafted by Watts did not address his situation. The CRA did not issue a refund and disallowed the business loss, denied the carryback and imposed a penalty. The taxpayer objected to the assessment, the CRA confirmed the assessment so the taxpayer appealed to the Tax court with a Canadian tax lawyer.
Appealing Gross Negligence Penaltiess
In order be assessed a penalty under section 163 of the Income Tax Act ("The Act") the CRA must prove that (1) the taxpayer made a false statement or omission in their income tax return, and (2) that the statement or omission was either made knowingly, or under circumstances amounting to gross negligence. Thus, penalties assessed under section 163 are often referred to as gross negligence penalties.
In each of the above cases, it was overtly obvious that the taxpayers had committed tax fraud by having made false statements in their income tax returns. Each taxpayer claimed a business loss for a business that did not exist. The true issue in these cases was whether the CRA could prove that the misstatement was made knowingly, or whether the taxpayer was grossly negligent.
If the CRA cannot prove that the taxpayer knowingly made a misstatement or omission they will attempt to prove that the taxpayer was grossly negligent. In Villeneuve v Canada [2014 FCA 20] the Federal Court of Appeal found that gross negligence, for the purpose of the Tax Act, could include "willful blindness". The Torres et. Al v The Queen [2013 TCC 380] ("Torres") case succinctly summarizes the general legal principles with respect to wilful blindness in gross negligence penalty cases. The Torres principles, as set out by Justice Miller, were affirmed by the Federal Court of Appeal in 2015. Please note that the Torres principles do not set out an exhaustive list of circumstances that would indicate a need for inquiry.
a. Knowledge of a false statement can be attributed to wilful blindness
b. Wilful blindness can be applied to gross negligence penalties under subsection 163(2) of the Act.
c. In determining wilful blindness, education and experience of the taxpayer must be taken into consideration.
d. To find wilful blindness there must be a need or a suspicion for an inquiry.
e. Circumstances that would indicate a need for an inquiry prior to filing include the following:
- the magnitude of the advantage or omission;
- the blatantness of the false statement and how readily detectable it is;
- the lack of acknowledgment by the tax preparer who prepared the return in the return itself;
- unusual requests made by the tax preparer;
- the tax preparer being previously unknown to the taxpayer;
- incomprehensible explanations by the tax preparer;
- whether others engaged the tax preparer or warned against doing so, or the taxpayer himself or herself expresses concern about telling others.
- The final requirement for wilful blindness is that the taxpayer makes no inquiry of the tax preparer to understand the return, nor makes any inquiry of a third party, nor the CRA itself.
Common Case Factors
The appeals of the gross negligence penalties by Canadian tax lawyers were successful in Anderson, Morrison and Sam. In each of these cases the gross negligence penalty was deleted. In the Sledge case however, the penalty was upheld.
In each case, the judge examined the conduct of the individual, taking into account their experience and education, to determine if enough "red flags" were raised that would indicate a need to investigate. The more frequently a taxpayer fails to inquire after a "red flag" is raised, the more likely the taxpayer will be found to be wilfully blind.
A key concept as to why Sledge was decided differently is due to the total lack of effort on the part of the taxpayer to verify the accuracy of his return. There is strong support in case law that stipulates that placing blind faith in preparers, without taking at least some steps to verify the correctness of information supplied, will not enable taxpayers to avoid gross negligence penalties. In essence, this all relates back to the idea of the self-reporting scheme where the taxpayer has an obligation to ensure the information supplied in their return is truthful. By placing full reliance on the accountant or tax preparer, the taxpayer is abandoning their obligations under the Act and may be subject to harsh penalties as a result. To certify a return with a signature without even looking at the contents will likely lead to an adverse outcome if obvious misstatements have been made.
In Anderson, more effort was undertaken on the part of the taxpayer to examine the information in their return. The taxpayer met with his tax preparer several times and even went so far as to fill in the tax preparer's name despite it being purposefully omitted. Inquiries were also made as to why the refund was so large, and a justification was provided to the taxpayer. In stark contrast, in Sledge, the taxpayer testified that he did not look at the numbers on his return, and that he did not see the box provided for the identification of professional tax preparers. When probed about the approximately $281,000 in business losses claimed, the taxpayer admitted that he saw it, but assumed it was a summation of all taxes paid for the previous 10 years. He made no inquiries. Further, the judge did not believe his testimony that he did not look at the large refund amount as generating a refund was the sole purpose for his dealings with Fiscal Arbitrators. In Slegde, the taxpayer's lack of both effort and credibility led to the upholding of the gross negligence penalties.
Another factor taken into consideration is how the taxpayer came into contact with the fraudulent tax preparer. In Morrison, the fact that the taxpayer had been referred by a friend of 30 years in a small town lessened the "need for inquiry" threshold. In Anderson, the taxpayer also relied on a recommendation from a long time friend. As opposed, in Sledge, the taxpayer could not even recall the last name of the friend from the barbershop who referred him to Fiscal Arbitrators. On a related note, if the tax preparer was able to produce credentials, as Rasool did in Anderson, the need for inquiry may also be reduced.
Whether the taxpayer was "pitched" a refund was also relevant in judicial analysis. In Sam, the taxpayer was referred to a fraudulent agent through a firm her sister had worked at for several years (DSC Lifestyle Services). The taxpayer was not "pitched" a program that would generate a refund. The taxpayer simply returned to the same location as she had in previous years in order to have her return prepared. Further, she had a history of receiving refunds, through legitimate means, which may also have lowered the threshold for a need for an inquiry for the tax year at issue.
How the taxpayer responded to inquiries made by the CRA about the business losses was also considered in the judicial analysis. Cases were decided more favorably where the response letters prepared by Fiscal Arbitrators were not sent to the CRA. In Morrison, the taxpayer read the letters he was provided by Fiscal Arbitrators. The taxpayer then realized that the letter was nonsensical and, instead of sending the prepared response, retained counsel. In Anderson, the letters were not sent because Rasool did not provide them to the taxpayer before he disappeared. In Sam and Sledge, the nonsensical response letters were signed by the taxpayer and were sent to the CRA. While Sam was decided favorably, the taxpayer was found to have "gone wrong" when she sent in the letters; however, the unique circumstances of not being explicitly "pitched" the refund scheme mitigated the damage done to her case by sending the nonsensical letters. As to why these letters were damaging, arguments were made that this type of conduct was indicative of the appellant's "trust" in the tax preparer. Strong legal precedent exists where "simply trusting" a preparer or "blindly trusting" a preparer, without taking efforts to become informed, may constitute gross negligence.
While many factors were considered, taxpayer efforts with respect to verifying the amounts in their returns and how the taxpayer came into contact with the tax preparer are extremely relevant to these types of decisions. Our experienced Toronto tax lawyers can advise on these CRA gross negligence penalty issues.
As you can see, these types of determinations are fact dependant and take into consideration many different factors and principles. Similar activities carried on by different taxpayers may yield opposite results in gross negligence penalty appeals. It is very much a threshold analysis where the court will take multiple factors into account in order to determine if the taxpayer crossed the line from "carelessness" or "naiveness" into wilful blindness. In summary, what it boils down to is whether a need for inquiry existed in the particular taxpayer's case, how strong that need was, and how the taxpayer responded to that need. Overall, if there is a significant lack of effort on the part of a taxpayer to verify blatantly obvious misstatements on their returns, like in Sledge, the court will likely uphold the penalty. If you find yourself in a situation where you have been accused of tax fraud or tax evasion and assessed a gross negligence penalty, a discussion with one of our top Toronto Tax Lawyers about your specific circumstances will greatly assist you in your objection and/or appeal process.
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.