Choptiany Et. Al. v The King, 2022 TCC 112: The Tax Court Of Canada Issues Scathing Rebuke Of CRA's "Outrageously Misleading And Inappropriate" Litigation Tactics In Tax Dispute Involving Gross-Negligence Penalties

• Published date: 24 October 2022
• Subject Matter: Litigation, Mediation & Arbitration, Tax, Trials & Appeals & Compensation, Professional Negligence, Income Tax, Sales Taxes: VAT, GST, Tax Authorities
• Law Firm: Rotfleisch & Samulovitch P.C.
• Author: Mr David Rotfleisch

Introduction: The Canada Revenue Agency's Overzealous Use of Gross-Negligence Penalties

Gross-negligence penalties serve to reprimand 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" (see: Venne v R., 84 DTC 6247). As such, the gross-negligence penalty can result in steep fines-up to 50% of the income tax that was underreported as a result of gross negligence, or 25% of the GST/HST 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 egregious example of this practice in Choptiany et. al. v The King, 2022 TCC 112. But what's more, in Choptiany, the CRA not only applied gross-negligence penalties with seemingly insufficient justification, but also employed stalling tactics during the tax litigation that compelled the Tax Court of Canada to allow the taxpayers' appeals outright-thereby cancelling their $3 million in combined gross-negligence penalties without their having to go to trial.

After analyzing the legislation and jurisprudence concerning gross-negligence penalties, this article examines the Tax Court's decision in Choptiany. We conclude the article by offering pro tax tips from our expert tax lawyers in Toronto on disputing gross-negligence penalties.

The Gross-Negligence Penalty: Subsection 163(2) of Canada's Income Tax Act & Section 285 of Canada's Excise Tax Act

Subsection 163(2) of Canada's Income Tax Act and section 285 of Canada's Excise 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

GST gross-negligence penalties are designed to punish. Hence, when 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, because of gross negligence, you filed an income-tax return that underreported your taxable income and thereby allowed you to evade $500,000 in income-tax liability. The resulting gross-negligence penalty equals $250,000 (i.e., 50% of the $500,000 in income tax otherwise payable but for the underreported taxable income).

Of course, the Canada Revenue Agency will assess the tax itself and interest, too. So, you'll need to pay the $250,000 gross-negligence penalty in addition to both (1) the $500,000 in income tax that you evaded and (2) the interest accruing on the total of $750,000 in income tax plus penalty. (And this doesn't even account for any additional exposure to tax-related criminal liability for tax evasion in Canada.)

The Burden of Proof is on the CRA: Reversed Onus

Gross-negligence penalties serve as a disciplinary mechanism for taxpayers who show exceptional 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.

As a result, gross-negligence penalties reverse the onus that would otherwise apply when other tax issues are under dispute. A taxpayer generally bears the initial burden of disproving the CRA's factual assumptions in a tax dispute. But 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, [2000] 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 raising doubt about 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.

In sum: 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"

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