Introduction – Income Tax Gross Negligence Penalties
Canadian individuals, corporations, and trusts which earn income during the year are generally required to pay income tax and file income tax returns. Taxpayers who do not file their income tax returns as and when required are subjected to a late filing tax penalty. If a taxpayer is audited by the CRA for income tax and the income tax auditor's analysis suggests that the taxpayer's return was inaccurate, the income tax auditor will propose corrective adjustments and consider applying an additional penalty under subsection 163(2) of the Income Tax Act. The tax penalties levied under this section are called gross negligence penalties.
Conditions for Application – Income Tax Gross Negligence Penalty
Subsection 163(2) of the Canadian Income Tax Act requires the Canada Revenue Agency to apply a harsh penalty to every person who knowingly or under circumstances amounting to gross negligence makes or acquiesces to a false statement or omission in a tax return, form, certificate, statement or answer with respect to a taxation year. For the purposes of simplicity, this article will focus on the case the where a misrepresentation or omission communicated through a tax return. The other cases have substantially the same legal treatment. In order for gross negligence penalties to apply, it must be the case that both:
- the return filed by the taxpayer was inaccurate in some way, and
- the taxpayer fell short of the proper standard of conduct at some point in the process of preparing and filing the return.
Determining whether a) is the case is a matter of applying the ordinary rules of the Canadian Income Tax Act and establishing the facts relevant to determining the taxpayer's duties under the Canadian Income Tax Act. For the taxpayer to satisfy b), the taxpayer must have either have made the tax misrepresentation knowingly, or the taxpayer must have been grossly negligent in the preparation of the return. The courts have interpreted the standard of what conduct constitutes gross negligence to be very high. For example, in Venne v the Queen, the court characterized gross negligence as "a high degree of negligence tantamount to intentional acting". The courts have also denied the CRA's attempts to levy gross negligence penalties in the following circumstances:
- the taxpayer sought professional-accounting assistance to complete tax returns
- the taxpayer made numerous errors on tax returns, indicating a lack of skill in accounting and tax matters
- the taxpayer disclosed all amounts at issue on his or her tax return
- the taxpayer found it difficult to operate accounting software
Burden of Proof – Income Tax Gross Negligence Penalty
To impose a gross-negligence penalty, the Canada Revenue Agency must discharge a weighty burden. In Findlay v Canada, the Federal Court of Appeal affirmed that the burden of proof lies with the CRA when it seeks to impose gross-negligence penalties. Moreover, the court held that the Canada Revenue Agency must carry this burden even if the taxpayer cannot provide a reasonable explanation for the act or omission underlying the CRA's tax penalty assessment. In other words, the Canada Revenue Agency invariably carries the onus of proving, on a balance of probability, that a tax gross-negligence penalty is deserved.
Quantum – Income Tax Gross Negligence Penalty
If the CRA imposes tax gross negligence penalties with respect to a misrepresentation that is relevant to determining the amount of income tax to be paid by a taxpayer for a taxation year, the amount of the gross negligence penalty is equal to 50% of the amount by which
- the income tax the taxpayer would required to pay for the taxation year if the taxpayer's taxable income for the year were computed by adding to the taxable income reported by the taxpayer that portion of the taxpayer's understated income that is reasonably attributable to the false statement or omission and if the taxpayer's income tax payable was computed by subtracting from the deductions from the tax otherwise payable by the taxpayer for the year such portion of any such deduction as may reasonably be attributable to the false statement or omission
- the amount of income tax the taxpayer would required to pay for the taxation year on the basis of the information provided in the taxpayer's return.
Note that the amounts to which the 50% penalty factor is applied are limited to the differences between what the actually taxpayer owes and the amount the taxpayer would owe based on the information in their return that are attributable to the grossly negligent misrepresentations or omissions. Differences that are the result of mistakes that are not attributable to gross negligence are not subject to the penalty. If a gross negligence penalty would be below $100, it is increased to $100.
Tax Tips – Income Tax Gross Negligence Penalty
If you have been charged with tax gross negligence penalties regarding income tax or are in the process of being audited for income tax, strongly consider consulting with one of our experienced Toronto tax lawyers. The standards that tax auditors use to apply tax gross negligence penalties are typically far harsher than those established by the courts. Gross negligence penalties applied by an auditor are frequently removed if the taxpayer hires an experienced Canadian tax lawyer to dispute the tax penalty through an objection filed with the CRA appeals division or through an appeal to the Tax Court of Canada.
If you are considering undertaking a transaction or taking a filing position of which you are uncertain, it is also highly recommended to retain one of our expert Toronto tax lawyers to provide advice or a tax planning memorandum. Not only will this increase the chance that you will structure the transaction properly or take the optimal filing position, it will considerably enhance the case that gross negligence penalties should not be applied to you should you ever be audited later. Having evidence available that you relied on the advice of highly qualified Canadian tax lawyers is one of the strongest defences possible against the imposition of gross negligence penalties.