Federal Court Of Appeal Overturns Tax Court's Decision And Vacates Gross-Negligence Penalties Because The Canada Revenue Agency's Evidence Was Exclusively About The Taxpayer's Spouse: Khanna V The Queen, 2022 FCA 84 ' A Canadian Tax Lawyer's Analysis

• Published date: 07 July 2022
• Subject Matter: Litigation, Mediation & Arbitration, Tax, Professional Negligence, Income Tax, Sales Taxes: VAT, GST
• Law Firm: Rotfleisch & Samulovitch P.C.
• Author: Mr David Rotfleisch

Penalties

Canada's tax statutes contain various penalties that seek to curb non-compliance. A gross-negligence penalty aims to punish a taxpayer 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 a gross-negligence penalty can be steep-equalling 50% of any income tax that was underreported as a result of gross negligence and 25% of any GST/HST that was underreported as a result of gross negligence.

Canada's tax legislation demands that the Canada Revenue Agency apply these penalties only in those clear cases warranting their use. Yet in many of the files in which our experienced Canadian tax lawyers have been involved, the CRA's tax auditors have routinely applied gross-negligence penalties without sufficient evidence of gross negligence. We find yet another example of this practice in Khanna v The Queen, 2022 FCA 84.

After analyzing the legislation and jurisprudence concerning gross-negligence penalties, this article examines the Federal Court of Appeal's decision in Khanna. Finally, it concludes by offering pro tax tips from our top Canadian tax-ligation lawyers on disputing and avoiding gross-negligence penalties.

Gross-Negligence Penalties: 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 contains the tax-penalty rules relating to gross-negligence penalties. These rules allow the Canada Revenue Agency to levy gross-negligence penalties 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 [that was] filed."

Section 285 of Canada's Excise Tax Act contains analogous tax-penalty rules 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 an prohibitive 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).

Suppose, for example, that, as a result of gross negligence, you filed an income-tax return that underreported your income, thereby allowing you to evade $500,000 in income-tax liability. The resulting gross-negligence penalty amounts to $250,000 (i.e., 50% of the $500,000 in tax otherwise payable but for the underreported income).

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

The Burden of Proof is on the CRA: Reversed Onus

Gross-negligence penalties aim to discipline taxpayers who flaunt remarkable disregard for Canada's tax rules. Hence, gross-negligence-penalty rules demand that the Canada Revenue Agency apply these penalties only in clear cases warranting their use.

To that end, these tax-penalty rules put the burden of proof on the Canada Revenue Agency. Although a taxpayer generally 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 "heavy" burden to impose a gross-negligence penalty: Corriveau v. R, [1999] 2 CTC 2580. 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 provide a reasonable explanation for the false statement or omission appearing in the tax return. In other words, even if the taxpayer remains silent, the Canada Revenue Agency still carries the onus of proving that the gross-negligence penalty was warranted.

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.

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."

The Elements of the Gross-Negligence Penalty: A False Statement or Omission Made "Knowingly or under Circumstances Amounting to Gross Negligence"

The previous section explained that the Canada Revenue Agency bears the burden of proving that gross-negligence penalties apply. But what exactly is it that the CRA must prove?

To successfully apply a...