Tax Court: No Penalty For Tax Return Filed Without Person's Knowledge

• Published date: 12 April 2021
• Subject Matter: Tax, Income Tax, Sales Taxes: VAT, GST
• 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 aim to punish 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": Venne v R., 84 DTC 6247. As such, the amount of the penalty can be steep-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 sufficient evidence of gross negligence. Bowker v The Queen, 2021 TCC 14, serves as yet another example of this practice.

After analyzing the legislation and jurisprudence concerning gross-negligence penalties, this article examines the Tax Court's decision in Bowker. Finally, it concludes by offering expert Canadian tax guidance on disputing and avoiding 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 contains 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 [that was] filed."

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

Gross-negligence penalties are designed to punish. Hence, if applied, gross-negligence penalties can result in an exorbitant 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, as a result of gross negligence, you filed an income-tax return that underreported your income, thereby allowing you to evade $500,000 in tax liability. The resulting gross-negligence penalty therefore equals $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 the $750,000 in tax and penalty. (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 serve as a disciplinary mechanism for taxpayers flaunting peculiar 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. So, while the 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, the Canada Revenue Agency always carries the onus of proving that a gross-negligence penalty is warranted even if the taxpayer is silent.

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."

Put simply, the Canada Revenue Agency bears the burden of proving that gross-negligence penalties apply. 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"

To successfully apply a gross-negligence penalty, the CRA must meet two criteria:

1. The Canada Revenue Agency must show that the taxpayer either made a false statement in a tax return or participated in, assented to, or acquiesced in the making of a false statement in a tax return.
2. The Canada Revenue Agency must establish that the taxpayer either did so knowingly or did so under circumstances amounting to gross negligence. (The CRA need not prove both knowledge and gross negligence; it only needs to show that the taxpayer displayed one of these two attributes.)

The...