29 March 2010 Internal T.I. 2009-0344291I7 - Calculating 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: Whether the gross negligence penalty is calculated on the entire unreported amount.

Position: It depends on the facts and whether a deductible amount is wholly attributable to the unreported amount.

Reasons: If the deductible amount is wholly attributable to the unreported amount, the penalty is calculated after the amount is deducted; if not, the penalty is calculated on the unreported amount first before considering the deductible amount.

								March 29, 2010

	Windsor Tax Services Office			HEADQUARTERS
	Audit Division					Income Tax Rulings
								  Directorate
	Attention: Kerry Peters, Team Leader	Lindsay Frank
	                 					(613) 948-2227

								2009-034429

Calculating the Gross Negligence Penalty

This is in reply to a memorandum of October 7, 2009, from Liz Purser, in which she is seeking clarification on the formula for calculating the gross negligence penalty on unreported income.

Ms Purser is processing an adjustment to increase a taxpayer's income by the amount of $18,065.00. She confirmed that that adjustment includes $6,350.00, which represents employment insurance benefits, and which paragraph 56(1)(a) of the Income Tax Act (the "Act") characterises as income. The taxpayer is entitled to a social benefits repayment deduction of $3,025.00 under s. 60(v.1), in respect of that income inclusion. A penalty under subsection 163(2) of the Act is contemplated, and clarification is sought as to the extent of the unreported income on which the penalty would be based.

Subsection 163(2) of the Act imposes a penalty on a taxpayer who knowingly, or in circumstances accounting to gross negligence, participates in, or makes a false statement or omission in, a tax return. The penalty is the greater of $100.00 and 50 per cent of the tax attributable to the false statement or omission, and is calculated by reference to the amount by which the taxpayer has understated the income for a particular year.

As was stated in Fortis v. M.N.R., [1986] 2 C.T.C. 2378 (T.C.C.), for subsection 163(2) to apply, there must be:

(a) a liability for tax;
(b) a false statement or omission in a return filed as required by or under the Act or a regulation;
(c) knowledge or gross negligence by the person in the making of a false statement or omission;
(d) an understatement of income for a year, as defined by subsection 163(2.1), that is reasonably attributable to the false statement or omission.

Paragraph 163(2.1)(a) defines "understatement of income" in subsection (2) to mean the amount by which the total unreported income exceeds the total of amounts deductible, but not deducted, by the taxpayer, see Wajsfeld v. R., [2005] 4 C.T.C. 2341 (T.C.C.).

To compute the amount in paragraph (a), it is necessary to analyse the rule determining whether the amount deductible is wholly applicable to the unreported income. If the deductible amount is wholly applicable to the unreported amount, the penalty is computed after the amount is deducted; on the other hand, if the deductible amount is not wholly applicable to the unreported amount, the penalty has to be calculated on the unreported amount computed before taking into consideration the deductible amount, see Roy v. R, [1998] 2 C.T.C 2982 (T.C.C.), aff'd in [2001] 3 C.T.C. 226 (F.C.A.). In this instant case, the relationship of the social benefits repayment amount to the unreported income must be considered.

Part VII of the Employment Insurance Act requires an individual, who has received employment insurance benefits in a year, and who has income for the year in excess of a stated limit, to repay a portion of such benefits. Such benefits are included in income under subparagraph 56(1)(a)(iv) of the Act, and such repayments are deductible under paragraph 60(v.1) in computing taxable income. Since the social benefits repayment is an amount which the taxpayer could deduct, it being wholly applicable to the unreported employment insurance benefits, the penalty must be computed after the social benefits repayment, namely, the sum of $3,025, is deducted from the unreported income.

To sum up, a gross negligence penalty is calculated on the unreported amount, net of any deductions directly attributable to that unreported amount. In this instance, the unreported amount related to employment insurance benefits, and the social benefits repayment amount is attributable to that income and, therefore, deductible prior to the calculation of the gross negligence penalty.

Should you need clarification or further information, please do not hesitate to contact Lindsay Frank at the number provided above.

B.J. Skulski
Manager
Insolvency and Administrative Law Section
Ontario Corporate Tax Division
Income Tax Rulings Directorate

c.c. Liz Purser
Technical Advisor
Audit Division
Windsor Tax Services Office