Introduction – modern tax penalties for modern tax planning
In the summer of 2000 Parliament introduced new penalty provisions to the Income Tax Act (section 163.2) and Excise Tax Act (section 285.1) relating to third party tax advisors such as tax accountants, tax preparers or tax lawyers. There are two penalties, a tax planner's penalty and a tax preparer's penalty. The initial aim of these tax advisor penalties was to deter and punish those who commercially promoted "tax shelters with inflated asset values and faulty assumptions". At the time of the legislation was first proposed the Department of Finance stated that the tax penalties were intended for egregious situations. However, given the very broad range of activities that fall within the scope of the tax penalty provisions, anyone who provides tax planning or tax preparation services could potentially be facing these penalties. Anyone who has been assessed penalties under these provisions should seek out a Canadian tax lawyer to ensure they are not paying the tax penalty unnecessarily and to protect their professional reputation.
The Tax Planner's Penalty & Tax Preparer's Penalty
The tax planner's penalty under subsection 163.2(2) applies to anyone who participates in the making of a statement that the tax planner knows, or would reasonably be expected to know but for culpable conduct, is false and that statement could be used by another person for the purposes of income taxation. This penalty could potentially apply to anyone who gives seminars or presentations to promote tax shelters where the audience is not the tax payer who ultimately relies on the statement, valuation appraisers who prepare false reports for proposed tax planning that could be used by unidentified investors, and countless other circumstances. The amount of the planner's penalty is the greater of $1000 and the total of the 'gross entitlements' obtained from the activity.
Both gross compensation and gross entitlements amount to all payments to be received, including contingent fees, by the advisor or someone the advisor does not deal with at arm's length in respect of the false statement.
The Meaning of 'Participate'
For either of the penalties to be applicable to anyone, the person assessed must have participated in the making of the false statement. Two specific definitions are included in the legislation. The first includes causing a subordinate to act or omit information, the second includes knowing of a subordinate who 'participates' in an act or omission of information and not making a reasonable attempt to prevent its occurrence. This is of course not a limited definition and interpretations of 'participate' beyond these two express definitions could apply to your actions if you work in tax consulting or tax preparation services.
The Meaning of 'Culpable Conduct'
In the absence of actual knowledge that the statements are false, the third party tax penalties can only be rightfully applied to a person if culpable conduct is present. This conduct is not merely the failure to exercise a reasonable standard of care. Culpable conduct is not a type of negligence but rather an act or failure to act that would be considered intentional, willful or reckless disregard for the truth or indifference as to whether compliance with the Income Tax Act or Excise Tax Act is achieved.
Whether a particular action or circumstances falls within the meaning of 'culpable conduct' or 'participate' is a question of law. If you have been assessed for these penalties on the basis of 'culpable conduct' or 'participating' and believe that the assessment is wrong on this question, you must seek out the opinion of an expert Canadian tax lawyer as any other consultant is not competent to provide such an opinion.
Good Faith Reliance & Honest Mistakes by third-party tax advisors
While both penalties are applicable to those who do not have knowledge that the statements involved are false if culpable conduct is present, subsection 163.2(6) provides for an exception. The penalties will not be applied where a the third party has made a false statement, but in doing so relied on information provided to them by the person who relied on the false statement. This narrow situation deals with someone such as a promoter of a tax shelter who provides false information to an advisor. Additionally, a failure to verify or investigate the accuracy of the information provided is not considered to be culpable conduct. To have relied in good faith means to have acted with honesty of intention and the absence of knowledge that ought to induce further inquiry. This exception is limited by the immediately following subsection in the act, which provides that the exception does not apply to excluded activity. The meaning of 'excluded activity' is expressly defined as the act of promoting or selling an arrangement where it is reasonable to consider the arrangement a tax shelter, where one of the main purposes is to obtain a tax benefit, or where subsection 66(12.68) applies (the filing obligation for flow-through shares of a corporation).
Burden of Proof & Statutory Obligation to Retain Records
Generally speaking the burden of proof for the application of these tax penalties falls on the CRA. The level of the burden is merely the balance of probabilities; however there are situations where the burden of proof does not fall within the general rules. For third parties who express an opinion as to the value of property or service, the value is deemed to be a false statement for the purposes of these penalty provisions if the opinion expresses a value outside the prescribed range of value. This creates a reverse onus of proof, where the person who made the statement must establish that the value is reasonable, made in good faith and not based on unreasonable assumptions. The use of a price adjustment clause also shifts the burden of proof onto the person who is potentially facing penalty. A price adjustment clause is often used in a contract of sale involving parties not dealing at arm's length to ensure compliance with the Income Tax Act. These clauses will not affect the finding of a false statement should the CRA decide the original filing position is incorrect unless certain filing obligations are met.
Tax Tip for third-party advisor tax penalties– Right of Appeal
Should you or your business face these tax penalties it is imperative to preserve your professional reputation. The only way to do this is to seek out professional Canadian tax lawyers prepared and experienced to handle the appeal and dispute process that begins with filing a Notice of Objection to your penalty assessment. Knowledge of the process is as important as knowledge of the tax law in this instance. For example, generally it is the internal policy of the Appeals branch to hold in abeyance an objection to these tax penalty assessments where the tax payer has also filed an objection to the underlying tax assessment in which a false statement is alleged. This is important information to the third party where the underlying return is in respect of the Excise Tax Act as, it will delay the processing of the objection, and the Excise Tax Act does not provide for the same restrictions on collections action during the appeals process as the Income Tax Act does.