Canada: Gross Negligence Penalties Upheld Against Wilfully Blind Sophisticated Taxpayer

Last Updated: August 30 2016
Article by John Sorensen

Most Read Contributor in Canada, October 2018

In Melman (2016 TCC 167), the Tax Court of Canada ("TCC") upheld gross negligence penalties on the basis that Mr. Melman was wilfully blind to a substantial omission in his tax return by admittedly not reviewing the return before it was filed. The appeal appears to have been filed as a mitigation strategy in the context of Mr. Melman's civil claim against his accounting advisors. Consequently, despite perhaps limited likelihood of success, Mr. Melman may have been obligated to advance the TCC appeal to demonstrate efforts to mitigate his damages.

Mr. Melman's 2007 return omitted $18,850,000 of taxable dividends (apparently grossed-up from dividends paid by two holding companies). According to the TCC, Mr. Melman was deeply involved in the declaration, calculation, payment and receipt of the dividends and, to facilitate paying the associated tax, he temporarily invested $4,725,000 in an instrument with a maturity date at the end of April, 2008. Mr. Melman was described as extraordinarily well-educated and successful and he frequently closely engaged with his tax and accounting advisors. The TCC's reasons included a factual summary that indicated timing challenges for preparing his 2007 return in April, 2008 and, in related communications between Mr. Melman and his accountants, an inexplicable absence of any reference to the taxable dividends and funds held to pay the tax. Mr. Melman's 2007 return was delivered to him at his home while a taxi waited for a member of the accounting firm to return her to the office once the return was signed. The preparation and signing of the return was rushed, as Mr. Melman was going out of town and the TCC described the execution of the return as a "drive-by signing". Mr. Melman did not review either a draft return or the version he signed that day. The omitted taxable dividend was detected during a CRA audit of Mr. Melman's holding companies about three years later and the CRA naturally reassessed. Mr. Melman did not contest the reassessment, other than the gross negligence penalties.

The TCC summarized well-established principles in penalties cases: gross negligence means neglect greater than failing to use reasonable care and is a high degree of negligence tantamount to intentional acting or indifference to compliance; wilful blindness may constitute gross negligence; and the criteria for finding wilful blindness include the magnitude of the error, opportunity for detection and the taxpayer's intelligence and education level. No single factor is determinative and the weighing of factors depends on context. The TCC found that Mr. Melman was highly intelligent and educated and perhaps one of the most experienced merchant bankers in Canada, with deep knowledge of finance: thus, he was the opposite of a more typical unsophisticated or inexperienced tax litigant. The TCC found that the size of the omitted dividends was very substantial and possibly unmatched in previous penalties cases. The error could have easily been detected. The TCC's analysis confirmed the wide discrepancy between actual and reported income: actual income was triple the reported income; actual dividend income was 7,300 times greater than reported dividends; and actual tax payable was 12.5 times greater than reported. The TCC inferred that such discrepancies would have been easily noticed by a taxpayer as remarkably capable as Mr. Melman.

The TCC stated that Mr. Melman's failure to review his return was out of character, but the rushed approach to preparing and signing the return accorded with his request to get his return done before he travelled. In the TCC's view, travel plans are not an excuse for failing to review a return. Further, the TCC stated that 2007 was a critical year for Mr. Melman and that his lack of review reflected indifference at an important juncture – namely, the execution of the return.

The TCC was troubled by the circumstances concerning the funds set aside to pay tax on the taxable dividends. Mr. Melman could not recall any communications from his bank regarding the investment of $4,725,000 that was to mature at the time the tax was payable and the TCC stated that the funds were "inexplicably redeployed contemporaneously with the filing of the 2007 return". In the TCC's view, the significant investment earmarked for paying tax maturing should have triggered an enquiry. Considering the totality of the circumstances, the TCC upheld the gross negligence penalties on the basis that Mr. Melman "averted his eyes" from the "strong amber beacons" that would have attracted a reasonable person's attention.

The takeaway from this case is straightforward: a taxpayer who signs a tax return certifies that the information on the return and in any attached documents is correct and complete and fully discloses all income – and failing to take the obvious step of reviewing a return coupled with later ignoring warning signs of a potential error will support gross negligence penalties. Finally, although the TCC appeal was likely an unavoidable mitigation strategy, query whether the TCC's finding of gross negligence by the taxpayer may ultimately prejudice his civil claim.

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.

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