It's Tax Season Again.
Taxpayers, particularly those not legally required to file tax returns, may be inclined to simply avoid the hassle of preparing and filing returns. However, there are numerous reasons to file tax returns on time. Failing to file on time can also lead to additional costs and expenses for taxpayers.
Late-Filing Tax Penalties
Under both the Excise Tax Act and Income Tax Act, filing a tax return after the deadline to file incurs a late-filing penalty. These penalties are calculated as a percentage of the tax owing and increase monthly up to a period of one year.
Failure to File Tax Returns Penalties
Under both the Excise Tax Act and Income Tax Act, a taxpayer who was required to file tax returns and does fails to file those tax returns can be assessed for failure to file tax return penalties. These penalties can compound where the taxpayer has failed to file on time for multiple reporting periods. Generally, these penalties are calculated based on the amount of tax owing.
Demand to File Tax Returns
The Canada Revenue Agency's Non-Filer agents contact taxpayers the Canada Revenue Agency believes are required to file tax returns but have not done so. They will provide the taxpayer with a set deadline to file a tax return. Failure to comply with a demand to file could lead to monetary penalties and/or an arbitrary tax assessment. These penalties may increase if the taxpayer has failed to file on time in the past.
Criminal Tax Charges and Penalties
Simply failing to pay your taxes will lead to bothersome, even crippling, enforcement action such as liens on your property and garnishment of your accounts or wages. Failure to pay one's taxes itself is not illegal or chargeable criminally though. Illegality arises where a taxpayer commits tax evasion - the intentionally falsified reporting of his, her or its taxes. In some circumstances, a complete failure to file one's required tax return could be sufficient to constitute intentional false reporting resulting in a criminal tax offence.
Arbitrary Tax Assessments
When a taxpayer fails to file their taxes, the Canada Revenue Agency can issue what is known as an arbitrary or notional tax assessment. These tax assessments are issued under subsection 152(7) of the Income Tax Act and subsection 299(1) of the Excise Tax Act. Since the taxpayer has not filed the required return, the Canada Revenue Agency will infer the taxpayer's appropriate tax filing position from information available to it, such as past tax returns. An arbitrary tax assessment will almost always result in more taxes owing than if the taxpayer had filed a return.
Once an arbitrary tax assessment is issued, the amount of tax assessed is legally collectable even if the amount of tax assessed is incorrect. The Canada Revenue Agency can and will take legal collection action, such as account or wage garnishments, to collect the assessed amounts. Canada Revenue Agency must generally wait 90 days after the issuance of an income tax assessment to take legal action but can act sooner in certain circumstances. GST/HST amounts are legally collectable the moment the GST/HST assessment is issued. Interest will also accrue on any unpaid amounts including penalties.
A taxpayer, usually after consulting with unexperienced Canadian tax lawyer, may attempt to correct the arbitrary tax assessment by filing a late return, effectively "papering over" the incorrect tax assessment. The Canada Revenue Agency is not required accept this late tax return. The taxpayer may also be required to prove the accuracy of their filing position through the tax audit process prior to the taxpayer's late return being accepted.
The taxpayer can also object to the arbitrary tax assessment. This formal notice of objection must be filed within 90 days of the assessment being issued, or 90 days plus a year from the assessment being issued if the Canada Revenue Agency approves a request for an extension of time. This is typically filed by a top Canadian tax professional. A notice of objection will halt collection action on income tax debts until the objection is resolved, but GST/HST tax debts remain collectable during the objection process. Interest continues to accrue during the objection process as well. The CRA Appeals Division may require the taxpayer to substantiate their correct filing position. An unsuccessful objection requires the taxpayer to retain a Canadian tax litigation lawyer to appeal to the Tax Court of Canada to challenge the tax assessment. If the tax appeal is unsuccessful, the taxpayer will continue to be held liable for the assessed amount, even if it is incorrect.
Arbitrary tax assessments can give rise to issues under derivative tax liability as well. Section 160 of the Income Tax Act allows the Canada Revenue Agency to hold a person who is not arm's length to the taxpayer liable for the taxpayer's unpaid taxes. A director can be held liable for the unremitted GST/HST or payroll remittances of the corporation. Though a person assessed under these derivative liability provisions can contest the underlying tax assessment, there is no guarantee the taxpayer will not be found liable for the arbitrarily assessed tax amount.
Arbitrary tax assessments can create an inflated tax liability for taxpayers, and potentially those who are not arm's length to the taxpayer. They may also trigger Canada Revenue Agency tax collections action if the taxpayer is unable to pay the unexpected additional tax debt. The easiest way to avoid an arbitrary tax assessment is simply to file your tax return by the deadline each year. The Canada Revenue Agency cannot arbitrarily assess a period for which a tax return has been properly filed.
Limitation Periods For Tax Reassessments and Tax Audits
After certain specified periods of time, the Canada Revenue Agency can no longer reassess or audit a taxpayer's previous taxation years. The clock starts on the limitation periods when the initial notice of assessment is issued. Unless an arbitrary tax assessment is issued, a notice of assessment for a particular reporting period will not be issued until the Canada Revenue Agency receives the taxpayer's tax return. The Canada Revenue Agency cannot reassess tax years where the notice of assessment was issued more than three years ago or audit tax years where the notice of assessment was issued more than four years ago without meeting the legal requirements to bypass these ordinary limitation periods.
To illustrate, in January 2020, Canada Revenue Agency informs taxpayers Jack and Jill that they are being audited for their 2013 taxation years. Jack filed his 2013 income tax return on time and received a notice of assessment in 2014. Jill never filed her 2013 income tax return, and thus never received a notice of assessment. Because Jack's notice of assessment was issued over four years ago, he can argue the Canada Revenue Agency is barred from auditing his 2013 taxation year. The Canada Revenue Agency is not barred from auditing Jill as no notice of assessment was ever issued. This example illustrates the importance of filing a tax return to potentially protect previous tax years from review.
Tax Credits Claimed By Filing Tax Returns
Many tax credits can only be claimed if the taxpayer files a tax return for the tax year in which the tax credit is earned. A taxpayer may not need the tax credit in the year it is earned, normally where the taxpayer may not have enough income to utilize the tax credit. The tax credits are still beneficial though. Tax credits can be used in other tax years to decrease the tax payable of the claimant and/or transferred to another taxpayer to decrease that taxpayer's tax payable. If a taxpayer has tax credits available, filing a tax return is necessary to maintain access to these credits.
The tuition tax credit is a good example of this. Many students do not earn enough income as students. The tuition tax credit can be carried forward to another tax year to lower the amount of tax owing in that tax year. There is no limit to how many years forward the credit can be carried, but it must be used as soon as the taxpayer has income to offset. The student could also transfer or assign his or her tuition tax credit to a spouse or common law partner or with some limitations, to a parent or grandparent to decrease his or her tax payable. To claim the tuition tax credit though, the student must file a return in the year the credit is earned. This makes it beneficial for students to file a return even if they do not earn income.
Instead of offsetting the taxpayer's income to decrease the taxes payable, some tax credits provide periodic tax-free payments to the taxpayer throughout the year. These include the GST/HST credit and Canada Child Benefit. Eligibility and the amounts of these payments are determined based on the income reported in the taxpayer's tax return. Taxpayers who fail to file a return could be missing out on tax-free income.
Pro Tax Tips: File Tax Returns to Obtain Tax Credits and Correct Past Non-Filing with a Voluntary Disclosure Application
The benefits of filing tax returns on time are numerous. You will receive tax credits that you might otherwise lose out on and will not be charged penalties and interest for late filing. If you have not filed tax returns on time the Canada Revenue Agency's Voluntary Disclosure Program allows taxpayers to avoid penalties and up to 50% of the interest on unpaid tax amounts. Taxpayers who have a return which is more than one reporting period past due and have not been contacted by the Canada Revenue Agency may use this tax amnesty program to file those late returns penalty-free. Our experienced Canadian tax lawyers can assist you with clearing up unfiled, past-due or incorrect tax returns.
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.