Am I Being Taxed or Penalized?
When a taxpayer receives an unexpected tax assessment from the Canada Revenue Agency, it can often feel like they are being penalized. However, there is a distinction between penalties and taxes. This distinction can impact the process used by experienced Canadian tax lawyer for appealing the imposition of the penalties or tax and the types and amount of relief available.
Penalty Example: Gross Negligence Penalties
Under Section 285 of the Excise Tax Act and Subsection 163(2) of the Income Tax Act, the Canada Revenue Agency can impose gross negligence penalties. When imposing these penalties, the Canada Revenue Agency is taking the position that the taxpayer knowingly or in manner which shows "a high degree of negligence tantamount to intentional acting" (Venne v. the Queen) under reported income or over claimed expenses leading to under reported taxes. The burden of proof for imposing these penalties lies with the Canada Revenue Agency. It must prove, on a balance of probabilities, that the gross negligence penalty is warranted. The Tax Court of Canada found in Hansen v. The Queen that the Canada Revenue Agency must give taxpayers the benefit of the doubt when an explanation by the taxpayer that does not justify applying the gross negligence penalties is sufficiently substantiated.
Tax Example: Over-Contribution Tax on TFSAs and RRSPs
When a taxpayer contributes more to his or her Tax-Free Savings Account (TFSA) or Registered Retirement Savings Plan (RRSP) than the contribution room the taxpayer has available for that year, an over-contribution tax may be applied. This tax is calculated at a rate of 1% of the over-contributed amount and applied for every month or part of the month the over-contribution remains in the taxpayer's account. With RRSPs, the over-contribution tax does not apply until over $2,000 is over-contributed. Many sources will wrongly refer to this tax as an "over-contribution penalty", but it is not a penalty but a tax.
How Tax Penalties are Calculated
In both the Income Tax Act and Excise Tax Act, penalties are generally calculated as the greater of:
- A small flat rate penalty
- A percentage of the under reported tax or over reported credits
For example, the gross negligence penalties discussed earlier are calculated as the greater of $100 and 50% of the amount which is the tax the taxpayer should have reported less the amount the taxpayer actually reported. Assume Karen and Sam both reported $100 in taxes in 2020, but the Canada Revenue Agency finds Karen should have reported $150 in taxes and Sam $1000 dollars in taxes. If the gross negligence penalties are applied, Karen would face a $100 penalty and Sam a $450 dollar penalty. Some penalties including the late filing penalty, which applies to returns filed after the deadline to file, and repeated failure to report penalty, which applies when a taxpayer fails to report income two or more times in a four year period, have no flat rate penalty and are calculated only on a percentage of the tax.
Penalties are calculated based only on taxes, not on other tax penalties. A taxpayer who files a tax return late then has gross negligence penalties applied will not have the late filing penalty factored into the calculation of the gross negligence penalty amount. Because penalties are calculated only based on a percentage of the tax, if a taxpayer successfully disputes the underlying tax, the penalties will also decrease.
Interest accrues on both penalties and tax, and will be decreased if the penalties and/or the tax are successfully disputed.
Discretionary Relief Available for Taxes vs. Penalties
Discretionary relief is relief that the Excise Tax Act or Income Tax Act has granted Canada Revenue Agency to provide to taxpayers. The Canada Revenue Agency administers these relief programs on behalf of the Minister of National Revenue based on their own administrative guidelines. With a few exceptions such as the over-contribution tax discussed above, discretionary relief is not generally available for taxes. The two most common forms of discretionary relief apply only to penalties and interest.
Taxpayer Relief Applications: A taxpayer relief application (previously called fairness relief) allows a taxpayer to apply for relief from penalties and/or interest where the penalties and/or interest arose due to circumstances outside of the taxpayer's control. These may include a medical emergency, or error by the Canada Revenue Agency. These applications do not allow taxpayers to obtain relief from the underlying tax.
Voluntary Disclosure Application: When a taxpayer discovers an error in previous reporting, or failed to file tax returns or to report income or alter assets entirely, that taxpayer may be eligible for a voluntary disclosure application. The voluntary disclosure application allows a taxpayer to proactively admit the error(s) to the Canada Revenue Agency in exchange for penalty relief and possible interest relief. These applications do not allow taxpayers to obtain relief from the underlying tax.
Remission Applications are a form of discretionary relief only granted in extraordinary circumstances, such as extreme financial hardship and unintended consequences of legislation. Unlike the forms of discretionary relief discussed above, remissions applications provide relief to both taxes and penalties. These applications are generally a taxpayer's last resort for relief and the only way to obtain relief with respect to taxes.
Pro Tax Tip: Notices of Objection Address Both Penalties and Taxes
A notice of objection is a formal appeal of a tax assessment filed with the Canada Revenue Agency, typically by a knowledgeable Canadian tax lawyer. The objection must be filed within 90 days of the date of the assessment, or 90 days plus a year with an extension of time application granted by the Canada Revenue Agency. The notice of objection allows a taxpayer to directly object to income assessed, expenses denied or taxes imposed, as well as some penalties including the gross negligence penalties. As previously mentioned, if the underlying tax is decreased, the penalties will decrease as well. Our top Canadian tax lawyers have extensive experience with preparing and pursuing successful notices of objection, as well as the applications for discretionary relief, including taxpayer relief applications, remission applications and voluntary disclosure applications, discussed above. Contact our experienced Canadian tax lawyers for assistance with tax and penalty relief.
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.