Tax Court Won't Uphold Gross-Negligence Penalties: Taxpayer Not Aware Of Accountant Errors

• Published date: 26 July 2021
• Subject Matter: Accounting and Audit, Litigation, Mediation & Arbitration, Tax, Accounting Standards, Professional Negligence, Income Tax, Sales Taxes: VAT, GST
• Law Firm: Rotfleisch & Samulovitch P.C.
• Author: Mr David Rotfleisch

Introduction: The Canada Revenue Agency's Hair-Trigger 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 25% of the GST/HST that was underreported as a result of gross negligence, or 50% of the income tax 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 example of this practice in Frank-Fort Construction Inc. v The Queen, 2020 TCC 6.

After analyzing the legislation and jurisprudence concerning gross-negligence penalties, this article examines the Tax Court's decision in Frank-Fort Construction. We conclude the article by offering pro tax tips and expert Canadian tax guidance on disputing and avoiding gross-negligence penalties.

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

Section 285 of Canada's Excise Tax Act and subsection 163(2) of Canada's Income 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

Gross-negligence penalties are designed to punish. Hence, if 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, due to gross negligence, you filed a GST/HST return that underreported your revenue, thereby allowing you to evade $500,000 in GST/HST (net tax) liability. The resulting gross-negligence penalty equals $125,000 (i.e., 25% of the $500,000 in GST/HST otherwise payable but for the underreported revenue). The Canada Revenue Agency will, of course, assess the tax and interest, too. So, you'll need to pay the $125,000 gross-negligence penalty in addition to both (1) the $500,000 in GST/HST that you evaded and (2) the interest accruing on the total of $625,000 in GST/HST plus penalty. (And this doesn't even account for any additional exposure to tax-related criminal liability for tax evasion.)

The Burden of Proof is on the CRA: Reversed Onus

Gross-negligence penalties serve as a disciplinary mechanism for taxpayers who show 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, although the taxpayer normally 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 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 casting doubt on the taxpayer's...