Introduction: The Canada Revenue Agency's Hair-Trigger Use of Gross-Negligence Penalties
Gross-negligence penalties aim to punish taxpayers whose conduct "involves a high degree of negligence tantamount to intentional acting, an indifference as to whether the law is complied with or not": Venne v R., 84 DTC 6247. As such, the amount of the penalty can be steep-up to 25% of the GST/HST that was underreported as a result of gross negligence, or 50% of the income tax that was underreported as a result of gross negligence.
Yet the Canada Revenue Agency's tax auditors have historically applied gross-negligence penalties without warrant-invoking the penalty almost as a matter of course when concluding a tax audit. We see yet another example of this practice in Frank-Fort Construction Inc. v The Queen, 2020 TCC 6.
After analyzing the legislation and jurisprudence concerning gross-negligence penalties, this article examines the Tax Court's decision in Frank-Fort Construction. We conclude the article by offering pro tax tips and expert Canadian tax guidance on disputing and avoiding gross-negligence penalties.
The Gross-Negligence Penalty: Section 285 of Canada's Excise Tax Act & Subsection 163(2) of Canada's Income Tax Act
Section 285 of Canada's Excise Tax Act and subsection 163(2) of Canada's Income Tax Act contain the provisions relating to gross-negligence penalties. These provisions allow the Canada Revenue Agency to levy the tax penalty upon any taxpayer "who, knowingly, or under circumstances amounting to gross negligence, has made or has participated in, assented to or acquiesced in the making of, a false statement or omission in [an income-tax return or a GST/HST return that was] filed."
Subsection 163(2) of Canada's Income Tax Act relates to incorrect income-tax returns, and it permits the Canada Revenue Agency to invoke a gross-negligence penalty when a taxpayer knowingly files an incorrect income-tax return or when a taxpayer files an incorrect income-tax return while displaying gross negligence. Section 285 of Canada's Excise Tax Act contains analogous provisions regarding GST/HST returns, thereby allowing the CRA to impose gross-negligence penalties on a taxpayer who knowingly files incorrect GST/HST returns or who files incorrect GST/HST returns while exhibiting gross negligence.
The Amount of the Gross-Negligence Penalty
Gross-negligence penalties are designed to punish. Hence, if applied, gross-negligence penalties can result in a hefty tax bill.
- In the case of incorrect income-tax returns, the amount of the gross-negligence penalty equals 50% of the tax on the understated income (with a minimum penalty of $100).
- In the case of incorrect GST/HST returns, the amount of the gross-negligence penalty equals 25% of the understated net tax (with a minimum penalty of $250).
For example, say that, due to gross negligence, you filed a GST/HST return that underreported your revenue, thereby allowing you to evade $500,000 in GST/HST (net tax) liability. The resulting gross-negligence penalty equals $125,000 (i.e., 25% of the $500,000 in GST/HST otherwise payable but for the underreported revenue). The Canada Revenue Agency will, of course, assess the tax and interest, too. So, you'll need to pay the $125,000 gross-negligence penalty in addition to both (1) the $500,000 in GST/HST that you evaded and (2) the interest accruing on the total of $625,000 in GST/HST plus penalty. (And this doesn't even account for any additional exposure to tax-related criminal liability for tax evasion.)
The Burden of Proof is on the CRA: Reversed Onus
Gross-negligence penalties serve as a disciplinary mechanism for taxpayers who show peculiar disregard for tax rules. Hence, Canada's tax legislation demands that the Canada Revenue Agency apply these penalties only in those clear cases warranting their use. So, although the taxpayer normally bears the initial burden of disproving the CRA's factual assumptions in a tax dispute, this burden is flipped when it comes to gross-negligence penalties. Subsection 163(3) of the Income Tax Act and subsection 285.1(16) of the Excise Tax Act each expressly say that the CRA bears the "burden of establishing the facts justifying the assessment of [a gross-negligence penalty]."
In principle, the Canada Revenue Agency must prove its case on a balance of probabilities. Yet the jurisprudence suggests that the CRA must in fact discharge a heavier burden to impose a gross-negligence penalty. In Findlay v Canada,  3 CTC 152, for instance, the Federal Court of Appeal not only affirmed that the burden of proof lies with the CRA but also held that the CRA must bear this burden regardless of whether the taxpayer can-or cannot-give a reasonable explanation as to how the false statement or omission made its way into the tax return. Indeed, in Lust v the Queen, 2009 TCC 577, the Tax Court went so far as to say that the Canada Revenue Agency's onus is in fact "greater than on a balance of probabilities and closer to the criminal onus under the Criminal Code."
Moreover, any evidence casting doubt on the taxpayer's culpability militates against applying a gross-negligence penalty. In Fourney v The Queen, 2011 TCC 520, the Tax Court of Canada explained that the benefit of any doubt must go to the taxpayer:
Because [a gross-negligence penalty] is penal in nature, it calls for a higher degree of culpability and must be applied only where the evidence clearly justifies so doing. If the evidence creates any doubt that it should be applied in the circumstances of the appeal, then the only fair conclusion is that the taxpayer must receive the benefit of that doubt in those circumstances.
Simply put: the Canada Revenue Agency always bears the burden of proving that gross-negligence penalties apply-even if the taxpayer says nothing on the issue.
But what exactly is it that the CRA must prove?
The Elements of the Gross-Negligence Penalty: A False Statement or Omission Made "Knowingly or under Circumstances Amounting to Gross Negligence"
To successfully apply a gross-negligence penalty, the CRA must meet two criteria:
- The Canada Revenue Agency must show that the taxpayer made a false statement in a tax return, or that the taxpayer participated in, assented to, or acquiesced in the making of a false statement in a tax return.
- The Canada Revenue Agency must establish that the taxpayer either did so knowingly or did so under circumstances amounting to gross negligence. (The CRA need not prove both knowledge and gross negligence; the CRA need only show that the taxpayer displayed one of these two attributes.)
The following sections discuss the false-statement requirement, the knowledge requirement, and the gross-negligence requirement in further detail.
The False-Statement Requirement
The false-statement requirement is relatively easy for the CRA to satisfy. The Canada Revenue Agency just needs to show that the tax return misrepresented a fact-e.g., purporting entitlement to a deduction that was in fact unavailable-or omitted something that should have been included-e.g., failing to report taxable income. In other words, the CRA can typically satisfy the false-statement requirement by demonstrating that a tax return purported something that was wrong or false. And this isn't a very high bar.
Still, the false statement or omission must appear in a tax return that the taxpayer actually filed. Although the failure to file tax returns might in some circumstances constitute tax evasion, it doesn't give rise to a gross-negligence penalty. For the gross-negligence penalty to apply, the legislation demands that the false statement or omission appear in a return that the taxpayer actually filed (see: Lee v The Queen, 2010 TCC 400; Calandra v The Queen, 2011 TCC 7; Khan v The Queen, 2011 TCC 481). So, gross-negligence penalties don't apply if the taxpayer hasn't filed a return.
Although the Canada Revenue Agency can typically prove the false-statement requirement, the CRA often faces problems while attempting to prove that the taxpayer met the knowledge standard or the gross-negligence standard. Our experienced Canadian tax lawyers have found that CRA tax auditors often ignore these requirements. Indeed, most of the jurisprudence concerning gross-negligence penalties centers on whether the taxpayer knew that the tax return contained a false statement or on whether the taxpayer exhibited gross negligence in filing a tax return containing a false statement.
The following two sections discuss the knowledge requirement and the gross-negligence requirement in turn.
The Knowledge Requirement
The Canada Revenue Agency can satisfy the knowledge requirement by proving that a taxpayer knowingly filed a tax return containing a false statement. The knowledge requirement imports a subjective test. That is, the inquiry is not whether the taxpayer ought to have known that a statement was false; it is whether the taxpayer subjectively knew about the false statement in the tax return: Fourney v The Queen, 2011 TCC 520, at paras 71-73, 78.
Wilful blindness entails knowledge. So, the CRA can satisfy the knowledge requirement by showing that the taxpayer wilfully turned a blind eye to false statements or omissions in the tax return. The Federal Court of Appeal has adopted the following definition: A "taxpayer is wilfully blind in circumstances where the taxpayer becomes aware of the need for inquiry but declines to make the inquiry because the taxpayer does not want to know, or studiously avoids, the truth. The concept is one of deliberate ignorance": Wynter v The Queen, 2017 FCA 195. In other words, wilful blindness basically covers those situations where you noticed something suspicious-i.e., something begging for further inquiry-yet opted to take the ignorance-is-bliss approach.
To establish wilful blindness, the CRA must prove the existence of suspicious circumstance indicating a need for the taxpayer to inquire about the tax return's accuracy. In Torres v The Queen, 2013 TCC 380, the Tax Court of Canada listed a number of red flags indicating that a taxpayer had exhibited wilful blindness by ignoring the suspicious behaviour of an accountant or other tax preparer:
- 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; and
- whether others engaged the tax preparer or warned against doing so, or the taxpayer himself or herself expresses concern about telling others.
This isn't an exhaustive list, and a court is free to consider other relevant circumstances when determining whether a taxpayer exhibited wilful blindness.
The Gross-Negligence Requirement
The gross-negligence requirement is distinct from the knowledge requirement. While the legal standards of knowledge and of its sister concept, wilful blindness, both import a subjective test, the gross-negligence standard imports an objective test: "Gross negligence is distinct from wilful blindness. It arises where the taxpayer's conduct is found to fall markedly below what would be expected of a reasonable taxpayer. Simply put, if the wilfully blind taxpayer knew better, the grossly negligent taxpayer ought to have known better. [.] While subjective considerations may play a role in either analysis, gross negligence is determined with reference to an objective test." Wynter v The Queen, 2017 FCA 195.
The CRA need not prove both knowledge and gross negligence; the CRA only needs to show that the taxpayer possessed one of these two attributes. So, even if the Canada Revenue Agency cannot establish that the taxpayer knew about the false statement, the gross-negligence penalty may still apply if the taxpayer exhibited gross negligence when making or acquiescing to the false statement appearing in a tax return. And because gross negligence doesn't require actual knowledge and permits the court to ask whether a taxpayer ought to have known better, it's easier for the CRA to prove gross negligence than it is to prove knowledge.
That said, gross negligence isn't merely the failure to act as a reasonable person would. Such conduct implies negligence, but not gross negligence. Gross negligence requires far more egregious behaviour. Carelessness doesn't cut it. Instead, the Canada Revenue Agency "must prove a high degree of negligence, one that is tantamount to intentional acting or an indifference as to whether the law is complied with or not. A taxpayer may avoid these penalty provisions where he or she has relied on the erroneous advice of a tax advisor and has not knowingly failed to report income or a capital gain": Zsoldos v. Canada (Attorney General), 2004 FCA 338, at para 21.
Hence, courts have denied the CRA's attempts to levy gross-negligence penalties in the following circumstances:
- the taxpayer sought professional-accounting assistance to complete tax returns: Hine v R, 2012 TCC 295.
- the taxpayer made numerous errors on tax returns, indicating a lack of skill in accounting and tax matters: Fourney v the Queen, 2011 TCC 520.
- the taxpayer disclosed all amounts at issue on his or her tax return: Crown Cork & Seal Canada Inc v The Queen,  2 CTC 465.
- the taxpayer found it difficult to operate accounting software: Fourney v the Queen, supra.
So, even though gross negligence elicits an objective standard, courts trounce the Canada Revenue Agency when its tax auditors apply gross-negligence penalties in cases involving ordinary negligence because "these penalties are meant to capture serious conduct": Wynter v The Queen, 2017 FCA 195, at para 21 (quoting the Supreme Court of Canada's decision in Guindon v. Canada, 2015 SCC 41, at para 61).
The Accountant Blunders on Taxpayer's GST Returns: Frank-Fort Construction Inc. v The Queen, 2020 TCC 6.
In 2006, Mr. Fernandes incorporated Frank-Fort Construction Inc. (the "Corporation"), which would carry on a land-development and construction business.
Mr. Fernandes was the Corporation's sole shareholder, director, and employee. As a 25-year old with only a high-school diploma and no experience with accounting or tax, Mr. Fernandes decided to hire tax professionals for assistance with the Corporation's accounting needs and tax obligations.
To this end, he hired both an invoicing company and a chartered professional accountant (CPA). The invoicing company managed the Corporation's bank account, issued invoices on the Corporation's behalf, and handled payments to the Corporation's subcontractors. The chartered-professional-accounting firm handled the Corporation's bookkeeping and accounting, and it prepared the Corporation's financial statements, GST/QST returns, and income-tax returns. Mr. Fernandes later stated that he had decided "to give all the accounting from A to Z to CPAs." Mr. Fernandes also explained that, although the Corporation could have hired an in-house bookkeeper, he preferred "to hire a CPA firm to ensure that [the Corporation's] accounting and [tax] returns were done properly and in compliance with tax laws."
After a tax audit revealed that the Corporation had omitted some sales from its Quebec sales tax (QST) returns, Mr. Fernandes fired his accounting firm and moved to another CPA firm. Yet Mr. Fernandes was eventually persuaded to return to the original accountants because they had assured him that they would do things differently and give the Corporation's business "special attention."
Mr. Fernandes provided the accountants with all the information and documents that they required to prepare the Corporation's income-tax returns and GST/QST returns. This information typically included the legal agreement and statement of disbursements for each building that the Corporation sold, the Corporation's bank-account statements, and a spreadsheet identifying the Corporation's monthly or quarterly sales. Moreover, the Corporation's chartered professional accountants also had access to the records maintained by the Corporation's invoicing company.
But a subsequent tax audit revealed that the Corporation had yet again failed to report sales on its tax returns. This time around, the omission involved the Corporation's GST returns. The omission stemmed from a bookkeeping error by the Corporation's accounting firm. In particular, when preparing the Corporation's accounting books, the accounting firm had incorrectly recorded deposits of sales revenue as mortgage advances. Because the accounting entries were incorrect, the Corporation's GST returns failed to report the Corporation's revenues from selling two buildings in November 2011.
Although a bookkeeping error had caused the mistake, the tax auditor still hit the Corporation with a gross-negligence penalty under section 285 of Canada's Excise Tax Act. The Corporation's experienced Canadian tax litigator objected to the gross-negligence penalties, and the dispute ultimately ended up before the Tax Court of Canada.
The Tax Court of Canada made short work of the issue, concluding that the Corporation hadn't committed "a high degree of negligence tantamount to intentional acting" because it "did not know and could not have known that there were omissions in its GST return." During the hearing, Mr. Fernandes and his accountant gave conflicting testimony, but the court accepted Mr. Fernandes's version as credible because "his version of the facts was consistent." The accountant, however, "avoided answering questions, was hostile, and reluctantly admitted that the accounting entries made in [the Corporation's] file were not consistent with the facts." Not only were the accounting firm's bookkeeping errors responsible for the incorrect GST returns, but the accountant himself admitted that he had known about the error for several years before the audit. Yet the accountant neither corrected the error nor informed Mr. Fernandes that the Corporation's GST returns were incorrect.
The court next turned to the issue of whether the Corporation (through Mr. Fernandes) had exhibited wilful blindness by relying so heavily on the accounting firm. The court explained that gross-negligence-penalty jurisprudence had settled upon "the proposition that an accountant's error will not automatically clear a taxpayer of any imposition of [gross-negligence] penalties under section 285 of [the Excise Tax Act]." Instead, each case "must be analyzed based on its own factual background," and the "taxpayer's behaviour must be taken into account."
Wilful blindness, the court reasoned, didn't come into play here. Mr. Fernandes simply didn't hire the accounting firm and thereafter wash his hands of responsibility; he "did everything he could to ensure that [the Corporation's] GST returns complied with the [Excise Tax Act]. He ensured that the accounting had access to all of the invoicing company's data, including all information about the Corporation's sales. Mr. Fernandes also provided the accountants with any additional information and documents that they required to prepare the Corporation's income-tax returns and GST/QST returns, including sales agreements, statements of disbursements, bank-account statements, and spreadsheets identifying the Corporation's monthly or quarterly sales. Moreover, during the hearing, when the accountant was asked whether Mr. Fernandes could have done anything that would have allowed the Corporation to avoid the omissions, the accountant replied, "no." In addition, the court also discovered that the accounting firm had seemingly signed and filed the impugned GST return without giving Mr. Fernandes a chance to review the return.
After concluding that the Corporation was neither wilfully blind nor grossly negligent, the Tax Court of Canada allowed the Corporation's appeal and vacated the gross-negligence penalties.
Pro Tax Tips & Expert Canadian Tax Lawyer Tax Guidance - Disputing & Avoiding Gross-Negligence Penalties
Frank-Fort Construction illustrates the all-to-common CRA practice of applying gross-negligence penalties without sufficient evidence. If a Canada Revenue Agency tax auditor has reassessed you for gross-negligence penalties, you may dispute the tax auditor's decision by filing a notice of objection.
A notice of objection prompts the CRA's administrative dispute-resolution process, and the Canada Revenue Agency's Appeals Division will assign an appeals officer to review the merits of your objection. If the CRA's appeals officer renders an unfavourable decision, you may continue the dispute by filing a notice of appeal to the Tax Court of Canada. (In the alternative, you may effectively bypass the CRA's Appeals Division and appeal directly to Tax Court if the Appeals Division hasn't rendered a decision within 90 days from the date that you filed your objection.)
That said, you have only a limited amount of time to object to an assessment or reassessment for gross-negligence penalties. Generally, you must object within 90 days from the date on the assessment or reassessment, and you must appeal to the Tax Court of Canada within 90 days from the date of a notice of confirmation from the CRA's Appeals Division. You may, however, qualify for a deadline extension, given that you apply for the extension within one year and 90 days from the date on the assessment or confirmation. If you fail to object within these statutory deadlines, you'll remain liable for the gross-negligence penalty-even if the Canada Revenue Agency failed to discharge the burden of proving that the gross-negligence penalty was warranted.
So, if you have been assessed for gross-negligence penalties under section 285 of Canada's Excise Tax Act or under subsection 163(2) of Canada's Income Tax Act speak to our Certified Specialist in Taxation Canadian tax lawyer today. Our experienced Canadian tax lawyers thoroughly understand this area of law, and we can ensure that you deliver a forceful, thorough, and cogent objection to the Canada Revenue Agency or appeal to the Tax Court of Canada.
If you filed Canadian tax returns that omitted your GST/HST or underreported your taxable income, you risk facing not only civil monetary penalties, such as gross-negligence penalties, but also criminal liability for tax evasion. But you may qualify for relief under the Canada Revenue Agency's Voluntary Disclosures Program (VDP), also known as tax amnesty. If your VDP application qualifies, the CRA will renounce criminal prosecution and waive gross-negligence penalties (and may reduce interest). A voluntary-disclosure application is time-sensitive, however. The CRA's Voluntary Disclosures Program will reject an application-and thus deny any relief-unless your application is "voluntary." This essentially means that the Voluntary Disclosures Program must receive your voluntary-disclosure or tax-amnesty application before the CRA contacts you about the non-compliance that you seek to disclose.
Our expert Canadian tax lawyers have assisted numerous Canadian taxpayers with unremitted GST/HST, with unreported income, and with incorrectly claimed expenses, tax deductions, and input tax credits. We can carefully plan and promptly prepare your voluntary-disclosure application. A properly prepared disclosure application not only increases the odds that the CRA's Voluntary Disclosures Program will grant tax amnesty but also lays the groundwork for a judicial-review application to the Federal Court should the Canada Revenue Agency unfairly deny your voluntary-disclosure application.
To determine whether you qualify for the Voluntary Disclosures Program, schedule a confidential and privileged consultation with one of our skilled Canadian tax lawyers. The Canada Revenue Agency cannot compel the production of information protected by solicitor-client privilege. Hence, solicitor-client privilege prevents the CRA from uncovering the legal advice that you received from our top Canadian tax lawyers.
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.