23 April 2013 Internal T.I. 2013-0485161I7 - Calculation of Gross Negligence Penalty

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: How is the gross negligence penalty calculated?

Position: The penalty is calculated by adding to taxable income reported by the taxpayer the full amount of the taxpayer's understatement of income for a particular year.

Reasons: Subsection 163(2.1) includes in understatement of income the full amount deducted by the taxpayer in computing income for the year.

April 23, 2013

XXXXXXXXXX Tax Services Office HEADQUARTERS
Income Tax Rulings Directorate
Attention: XXXXXXXXXX Lindsay Frank
Team Leader, Appeals Division (613) 960-7919

2013-048516

Calculation of Gross Negligence Penalty

We are replying to your request for a technical interpretation concerning the calculation of the gross negligence penalty under subsection 163(2) of the Income Tax Act, R.S.C. 1985 (the "Act").

A taxpayer claimed a business loss on his T1 return. He applied a sufficient amount of that loss to reduce his taxable income to nil. He then requested that the balance be carried back to the three prior taxation years pursuant to section 111 of the Act. The loss was fictitious and was denied. In addition, penalties were assessed under subsection 163(2). The penalty was calculated based on the full amount of the loss reported.

The taxpayer disagrees with the calculation of the amount of the penalty. In his view, the understatement of income used to calculate the penalty cannot exceed the current year's actual income. Rather, the penalty should be calculated on the basis of a principle in Udell v. M.N.R., 70 D.T.C. 6019 (Ex. Ct.) ("Udell"), that is, the amounts carried back to the prior years should be included in the understatement of income for those years pursuant to paragraph 163(2.1)(c). The taxpayer also asserts that the penalty can only be applied where he was assessed based on the false statement. Since the false statement was caught before his return was assessed, the penalty should be nil.

Our Comments

That principle in Udell is no longer relevant as it was based on the wording of the then penalty provision, subsection 56(2) of the Income Tax Act R.S.C. 1952, (the "pre-1972 Act"), which levied the penalty on the taxation years to which the loss was used. The penalty provision has since been amended and now appears in subsections 163(2) and (2.1) of the present Act. A provision similar to subsection 163(2.1), which defines "understatement of income", did not exist in the pre-1972 Act.

Subsection 163(2) permits the Minister to impose a gross negligence penalty on a taxpayer who knowingly, or in circumstances amounting to gross negligence, participates in, or makes a false statement or omission in a return. Under this provision, a return includes a form, certificate, statement, or answer filed or made.

The penalty is the greater of $100 and fifty per cent of the tax attributable to the false statement or omission. It is calculated by adding to the taxable income reported by the taxpayer the amount of the understatement of income for a particular year. Moreover, it is applied to the false statement or omission and is not dependent on the Minister assessing the taxpayer based on the false statement.

Under paragraph 163(2.1)(b), understatement of income is defined to include any amounts that the taxpayer has deducted, but were not deductible, in computing income for the year. As a result, where the taxpayer has reported a fictitious loss that exceeded taxable income, the understatement of income includes the full amount of the loss reported and not just the portion that the taxpayer deducted to bring taxable income to nil. Further, paragraph 163(2.1)(c) does not apply to include in the understatement of income of a year when the fictitious loss was claimed because the paragraph specifically excludes amounts deducted under section 111.

For more details on the calculation of the penalty, please refer to technical interpretation E2012-0452151I7. Further, should you have any questions or require additional information, please do not hesitate to contact Lindsay Frank at the number provided above.

Yours truly,

Terry Young, CA, CPA
Manager, Administrative Law Section
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch