A Canadian Tax Lawyer's Perspective On Gross Negligence Penalties And Net Worth Tax Audits

• Published date: 12 November 2021
• Subject Matter: Accounting and Audit, Litigation, Mediation & Arbitration, Tax, Audit, Professional Negligence, Income Tax
• Law Firm: Rotfleisch & Samulovitch P.C.
• Author: Mr David Rotfleisch

What are Net Worth Tax Audits?

A net worth audit is an indirect tax audit technique used by the Canada Revenue Agency or CRA where it has cause to believe the taxpayer's usual records are not an accurate reflection of the taxpayer's income. To conduct a net worth audit, the CRA will examine a variety of documents including bank records, title registries and the records of related taxpayers such as family members or corporations owned by the taxpayer under tax audit. Using this information, the auditor will assess the change in the taxpayer's assets and liabilities (net worth) over the tax audit period. If this change is not consistent with the taxpayer's tax reporting it suggests the taxpayer had unreported income and the CRA will reassess the taxpayer for the amounts determined under the net worth tax audit method.

For more on Net Worth Audits, please see our article on the CRA Net Worth Audit.

What are Gross Negligence Penalties?

Under subsection 163(2) of the Income Tax Act, the CRA can assess a type of tax penalty known as a gross negligence penalty. This tax penalty is applied where a taxpayer either knowingly, or "under circumstances amounting to gross negligence" reports information incorrectly on a tax return or tax form, or omits information on a tax return or tax form. A taxpayer may be assessed for gross negligence penalties where, for instance, the taxpayer fails to report income from work done on a cash basis "under the table" when the taxpayer was aware that income needed to be reported.

Gross negligence penalties can be quite steep. They are calculated as the greater of:

1. $100
2. The difference between the income tax which resulted from the taxpayer's reporting and the income tax that should have resulted had the taxpayer reported correctly.

Our experienced Canadian tax lawyers have caused the CRA to reverse the assessment of gross negligence penalties by advancing arguments such as the taxpayer's reliance on tax professionals, that the taxpayer had reasonable cause to believe his or her reporting was correct, or that the CRA's burden of proof to impose these penalties has not been discharged.

The Application of Gross Negligence Penalties in Net Worth Audit Cases

The CRA's use of the net worth audit method is generally considered controversial by top Canadian tax lawyers. While the CRA may argue the method is reasonably reliable and the best they can do where the usual records kept by taxpayers cannot be relied on, the results of a net worth...