Compliance Programs Branch (DCPB)

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Chapter 28.0 Penalties

Table of Contents

• 28.1.0 Overview
• 28.2.0 Failure to file a return or provide information
  • 28.2.1 For future use
  • 28.2.2 Late filing of income tax return
  • 28.2.3 Other penalties provided in section 162 of the ITA
  • 28.2.4 Foreign reporting – Penalties and offences
• 28.3.0 Repeated failures – Subsection 163(1) of the ITA – Under review
  • 28.3.1 Conditions for applying the penalty
  • 28.3.2 Exceptions
  • 28.3.3 Audit covering several years
  • 28.3.4 Bankrupt taxpayer
  • 28.3.5 Minimum thresholds
  • 28.3.6 Burden of proof – Subsection 163(3) of the ITA
  • 28.3.7 Communication with the taxpayer
  • 28.3.8 Provincial and territorial income tax provisions regarding repeated failure to report amounts
• 28.4.0 False statements or omissions
  • 28.4.1 General comments
  • 28.4.2 Knowingly or under circumstances amounting to gross negligence
  • 28.4.3 General rules
  • 28.4.4 Specific factors to consider when imposing gross negligence penalties
  • 28.4.5 Situations where a gross negligence penalty is not imposed
  • 28.4.6 Taxpayer or agent’s responsibility
  • 28.4.7 Minimum thresholds
  • 28.4.8 Burden of proof
  • 28.4.9 Net worth assessment – Under review
  • 28.4.10 Assessment based on unidentified deposits
  • 28.4.11 Assessment based on the assessing projections technique
  • 28.4.12 Suppressed income of a corporation appropriated by shareholders
  • 28.4.13 Reopening statute-barred years
  • 28.4.14 For future use
  • 28.4.15 Application of penalty in specific income tax situations
  • 28.4.16 Application of gross negligence penalty to Scientific Research and Experimental Development claims
  • 28.4.17 Calculation of the penalty for false statements or omissions
  • 28.4.18 Other gross negligence penalties
  • 28.4.19 References – Penalty for false statements or omissions
  • 28.4.20 Provincial and territorial income tax provisions regarding gross negligence penalties
• 28.5.0 Third-party civil penalties
• 28.6.0 Penalties for late-filed and/or amended elections under the ITA
  • 28.6.1 Section 85 rollovers
  • 28.6.2 Late-filed capital dividends election
  • 28.6.3 Taxpayer relief provisions – Late, amended, or revoked elections
• 28.7.0 Failure to deduct, withhold, collect, remit, or pay an amount
  • 28.7.1 Failure to deduct or withhold an amount – ITA
  • 28.7.2 Failure to remit an amount withheld – ITA
  • 28.7.3 Directors’ liability – Failure to deduct or remit income tax
• 28.8.0 Miscellaneous penalties
  • 28.8.1 Unfounded appeal
• 28.9.0 Penalties under the transfer pricing provisions
• 28.10.0 For future use
• 28.11.0 Due diligence – Cancellation or waiver of penalty
  • 28.11.1 Background information
  • 28.11.2 Due diligence – Section 233.5 of the ITA
• 28.12.0 Cancellation and/or waiver of penalties under the taxpayer relief provisions
• 28.13.0 For future use
• 28.14.0 Offences and penalties
  • 28.14.1 Overview – Under review
  • 28.14.2 Summary of offences
  • 28.14.3 Improper communication, use or disclosure of confidential information

28.1.0 Overview

Penalties imposed under the Income Tax Act (ITA) may be categorized as:

• failure to file an information return
• penalty for false statements or omissions – civil or criminal
• penalty for repeated failures
• penalties that relate to elections – late filing, amendment, or revocation of election
• penalty for failure to withhold or collect tax
• third-party penalty (effective June 29, 2000) and
• other penalties, including penalties unique to the ITA

The minister may waive or cancel all or a portion of any penalty payable by the taxpayer in certain situations. For more information, go to 28.12.0, Cancellation and/or waiver of penalties under the taxpayer relief provisions.

The Taxpayer Bill of Rights states that taxpayers have the right to relief from penalties and interest under tax legislation because of extraordinary circumstances. For more information, go to the Taxpayer Bill of Rights.

28.2.0 Failure to file a return or provide information

28.2.1 For future use

28.2.2 Late filing of income tax return

The late-filing penalty under subsection 162(1) of the ITA is based on the unpaid amount of Part I tax payable for the year at the time the return was required to be filed by subsection 150(1). As stated in subsection 162(11), the penalty is calculated on the Part I tax payable before taking into consideration the specified future tax consequences, such as any reduction as a result of the application of any subsequent carrybacks applied.

The late-filing penalty is equal to 5% of the unpaid amount, plus 1% for each complete month the return was late, to a maximum of 12 months. This is not a discretionary penalty and is automatically calculated and applied on assessment or reassessment.

Repeated failure to file

Subsection 162(2) of the ITA provides for the imposition of a substantially increased penalty (10% of the unpaid tax, plus 2% for each complete month, to a maximum of 20 months) if a taxpayer has failed to file a return for a year and:

• a penalty was payable under subsection 162(1) or 162(2) in respect of an income tax return for any of the three preceding taxation years; and
• a demand to file a return has been sent to the taxpayer under subsection 150(2)

28.2.3 Other penalties provided in section 162 of the ITA

For more information, go to Form T106, Information return of non-arm’s length transactions with non-residents.

Go to Foreign Reporting for more information about Forms T1134, T1135, T1141, and T1142.

Failure to file certain corporate returns

Section 235 of the ITA provides an additional penalty (as well as any other penalties payable) for every large corporation that fails to file:

• a return of income under section 150
• a return of capital under section 190.2 regarding the capital tax payable by financial institutions under Part VI

The penalty that applies to each late-filed return is based on the taxable capital employed in Canada and the tax that would be payable under Part VI of the ITA.

Failure to file in respect of tax shelters

Subsection 237.1(7.4) of the ITA provides a penalty for every promoter who files false or misleading information in applying for a tax shelter identification number or sells, issues, or accepts consideration in respect of a tax shelter before the identification number is issued. The penalty is the greater of $500 and 25% of the consideration received or receivable before the correct information is filed or the identification number issued.

For more information, go to Income Tax Information Circular IC89-4, Tax Shelter Reporting.

28.2.4 Foreign reporting – Penalties and offences

During an audit, the auditor may find that the taxpayer was required to file a foreign reporting information return and did not or that the taxpayer made a false statement or omission on a return that was filed. This may be the case whether or not there is related unreported income. Consider applying penalties when there is non-compliance with the foreign reporting requirements. Also consider penalties for unreported or underreported income, if applicable.

The categories of penalties include:

For more information, go to T106 - Audit Guide (including Database Guide) & Reference Manual (HQ1073-000-R) and Form T106, Information return of non-arm’s length transactions with non-residents.

Go to Foreign Reporting for more information about Forms T1134, T1135, T1141, and T1142.

28.3.0 Repeated failures – Subsection 163(1) of the ITA – Under review

Subsection 163(1) of the ITA imposes a penalty if a taxpayer has failed on more than one occasion to report an amount required to be included in computing the taxpayer’s income. The repeated failure to report income is enough for the penalty under subsection 163(1) to apply.

Penalties under subsection 163(1) do not apply to the overestimation of deductible expenses or to deducted personal expenses.

If fraud is suspected or the application of a penalty under subsection 163(1) is warranted and the adjustments are considerable, refer the case to the Criminal Investigations Division. It is mandatory to include a copy of all referrals and resulting reports in the audit file.

28.3.1 Conditions for applying the penalty

Subsection 163(1) of the ITA says that a person is liable to a penalty if:

• they have failed to report an amount, equal to or greater than $500, that was required to be reported in a taxation year;
• they have failed to report an amount, equal to or greater than $500, that was required to be reported in any of the three preceding taxation years; and
• gross negligence penalties are not being applied under subsection 163(2) regarding the same amount.

The amount of the penalty is determined by subsection 163(1.1) and is the lesser of:

• 10% of the unreported amount (which is the amount to be included in computing income prior to any deductions allowed under Part I, Subdivision B); and
• the penalty that would be determined under 163(2), if that subsection applied to the unreported amount, less 50% of any amount deducted or withheld under subsection 153(1) that may be reasonably considered to be in respect of the unreported amount.

It is not necessary that the second failure be from the same source as the first failure for the penalty to apply. As well, the omission need not be intentional.

28.3.2 Exceptions

The penalty under subsection 163(1) of the ITA does not apply if:

• the taxpayer did not file a return and does not have to file, even after the omitted income is taken into account;
• the understated income is because of errors in the characterization of income or in its computation, if all amounts required to be included in computing income are reported;
• the taxpayer failed to report income (in whole or in part), but included the information slips relating to the omission in the return filed;
• the taxpayer made a valid voluntary disclosure, unless it is obvious that the return was filed solely to avoid a late-filing penalty and an adjustment is being processed to include substantial additional income; or
• the taxpayer is deceased.

28.3.3 Audit covering several years

If returns are reassessed at the same time for several years, omissions of the same type of income in more than one of the returns will be treated as a single omission that applies to the most recent year reassessed. However, if the taxpayer had previously filed a return in one of the three tax years preceding the concurrent returns and failed to include an amount, penalties could be assessed in the case of the concurrent returns. This is particularly relevant when the taxpayer has previously been advised that the income was required to be included in reported income on the return.

When the returns have omissions of different types of income, an omission will be considered to have occurred in each year in which income was not reported. For more information go to Communiqué AD-13-01, Application of Subsections 163(1) and 163(2) of the Income Tax Act.

28.3.4 Bankrupt taxpayer

In the case of a bankrupt taxpayer, the omission of income in the year preceding bankruptcy or in prior years will not be considered a first omission when an adjustment to include unreported income is made in the year following the bankruptcy or in a subsequent year. Subsection 163(1) of the ITA does not apply in the first year after bankruptcy.

28.3.5 Minimum thresholds

The processing system calculates the penalty once a decision has been made to apply it. The penalty is processed only if the unreported income in each year is as outlined in Communiqué AD-13-01, Application of Subsections 163(1) and 163(2) of the Income Tax Act, under the section, Administration of Penalties.

28.3.6 Burden of proof – Subsection 163(3) of the ITA

As stated in subsection 163(3) of the ITA, the burden of establishing the facts to justify the assessment of a penalty under section 163 or 163.2 is on the minister when a taxpayer appeals the penalty.

28.3.7 Communication with the taxpayer

At the time of the first omission, the taxpayer should be advised of the consequences of another omission in the following three-year period. When it is determined that it is appropriate to levy a penalty under subsection 163(1) of the ITA, advise the taxpayer in writing that a penalty is being considered and give an opportunity to respond.

28.3.8 Provincial and territorial income tax provisions regarding repeated failure to report amounts

As of the revision date of this section, not all of the provinces and territories have updated their tax legislation to include the effects of subsection 163(1.1) of the ITA. For those acts below that make a reference to section 163 of the federal act, include a reference to subsection 163(1.1). Those acts that make a reference only to subsection 163(1) of the federal act are deemed to have a “dynamic” reference, which will include a reference to subsection 163(1.1). Any province or territory, notably Ontario, which has not made a reference to the federal act, will remain at the 10% penalty calculation until their legislation is amended.

28.4.0 False statements or omissions

28.4.1 General comments

Subsection 163(2) of the ITA provides for penalties, commonly referred to as “gross negligence penalties,” that apply if a person or partnership “knowingly or under circumstances amounting to gross negligence” makes or is otherwise involved in the making of “a false statement or omission” in a return or in giving information.

The penalty is determined, under the provisions of the ITA, with reference to the understatement of tax payable that is attributable to the false statement or omission. Gross negligence penalties under the ITA can apply to unreported income, overstated expenses, or improperly claimed personal expenses. The penalty also applies to false statements and omissions affecting tax credits and similar deductions from income tax payable, including the Canada Child Benefit and the goods and services tax credit.

The imposition of a gross negligence penalty under subsection 163(2) does not affect late-filing penalties imposed under subsection 162(1). However, subsection 163(1) and 163(2) penalties cannot be applied simultaneously. Penalties under subsection 163(1) will not be applied for repeated failures to report an amount if subsection 163(2) penalties have been applied.

28.4.2 Knowingly or under circumstances amounting to gross negligence

It is vital to understand the meaning of the term “knowingly or under circumstances amounting to gross negligence” to apply a gross negligence penalty.

Knowingly, as used in subsection 163(2) of the ITA, implies that a taxpayer knew or ought to have known that the amount of tax paid was less than should otherwise have been paid for the purposes of the ITA or that the amount of refund or rebate claimed was greater than the amount that the person was eligible to receive for the purposes of the ITA. Knew implies that a taxpayer deliberately or intentionally acted in such a manner, while ought to have known does not mean actual knowledge, but means that the taxpayer had in effect the means of knowledge.

Gross negligence, as used in subsection 163(2), covers a set of facts which clearly indicates either that the taxpayer knew or ought to have known that an offence was committed under this subsection or that the taxpayer acted so carelessly or so negligently that the way in which the taxpayer handled their affairs amounted to gross negligence (that is, negligence of conspicuous magnitude). The set of facts typically fall in the categories of “(a) the magnitude of the omission in relation to the income declared, (b) the opportunity the taxpayer had to detect the error, (c) the taxpayer's education and apparent intelligence, (d) genuine effort to comply.” [Lauzon v The Queen, 2016 TCC 71, para 29, and 2016 FCA 298] “Gross negligence may be established where a taxpayer is willfully blind to the relevant facts in circumstances where the taxpayer becomes aware of the need for some inquiry but declines to make the inquiry because the taxpayer does not want to know the truth” [Strachan v The Queen, 2015 FCA 60, para 4] and “consequently, the law will impute knowledge to a taxpayer who, in circumstances that dictate or strongly suggest that an inquiry should be made with respect to his or her tax situation, refuses or fails to commence such an inquiry without proper justification.” [Panini et al v The Queen, 2006 FCA 224, paragraph 43].

Go to 28.4.18, Other gross negligence penalties, for a list of court cases that discuss “knowingly” and “gross negligence.”

28.4.3 General rules

Communication with the taxpayer

A penalty for false statements or omissions cannot be applied, unless the person has first been informed that the assessment of such a penalty was being considered. The Taxpayer Bill of Rights states that the taxpayer has the right to complete, accurate, clear, and timely information.

For more information, go to:

• 11.2.0, Communications and negotiations with taxpayer and
• Taxpayer Bill of Rights

Assessment under subsection 152(7) of the ITA

Subsection 152(7) of the ITA gives the minister the authority to assess income tax payable if the taxpayer has not filed a return. Assessments under this subsection are raised by preparing proforma income tax returns.

The penalties for false statements or omissions do not apply to these assessments. As the taxpayer did not file a return for the period in question, the minister cannot prove that the person, knowingly or otherwise, made a false statement or omission in a return.

However, if the taxpayer subsequently provides a return for the year or period that has been assessed under subsection 152(7), gross negligence penalties may be levied if the conditions for their application are otherwise met.

For more information, go to:

• 9.5.0, Unfiled returns
• 11.4.3, Revocation of waiver
• subsection 152(7)

Time of the offence

An offence occurs when an income tax return is filed or when other documents for the purposes of the ITA are submitted. Events taking place subsequent to that time cannot be used to support the assessment of gross negligence penalties.

First occurrence

(Section removed)

Deceased and seriously ill individuals

Gross negligence penalties are not levied on the assessment or reassessment of the return of a deceased taxpayer.

Penalties should not be levied if the taxpayer is seriously ill and it would be inadvisable to interview or otherwise advise the taxpayer about the seriousness of the offence.

Voluntary disclosure

Taxpayers can make disclosures to correct inaccurate or incomplete information or to disclose information not previously reported. Taxpayers who make a valid voluntary disclosure will have to pay the taxes owing, plus interest. In this situation, the Canada Revenue Agency (CRA) can provide relief from penalties, including gross negligence penalties and prosecution that would otherwise be imposed. Relief is determined case-by-case, if the disclosure is voluntary, complete, involves a penalty, and includes information that is at least one year past due, or if less than one year past due, not initiated to avoid late-filing or instalment penalties.

For more information, go to:

• Voluntary Disclosures Program;
• Income Tax Information Circular IC00-1R6, Voluntary Disclosures Program.

Tax service office (TSO) Appeals Voluntary Disclosure Program (VDP) officers, team leaders, and Chiefs of Appeals are responsible for making decisions on the validity of voluntary disclosures. Although Appeals may refer the disclosure to Audit to determine if it is complete, the final decision on completeness rests with Appeals. If a disclosure is found to contain material errors or omissions, the disclosure will not qualify as a voluntary disclosure, with the result that the disclosed information may be processed and interest and penalties can be applied to the entire amount.

Fraud

If the audit shows that the taxpayer may have committed fraud, the file is to be referred to the Criminal Investigations Division. It is mandatory to include a copy of all referrals and resulting reports in the audit file.

If the file is not accepted for investigation and returned to Audit for reassessment, gross negligence penalties can be levied at that time, if appropriate. For more information, go to 10.11.8, Referrals to the Criminal Investigations Division.

Fraud involves an intent to deceive that is beyond negligence. Fraud is a deliberate understatement of tax and always includes three elements:

1. mens rea – a criminal or guilty intent, because the person or representative failed to make a statement or knew that a statement was false;
2. a misrepresentation, such as a material omission; and
3. serious prejudicial impact on the CRA.

Fraud is an intentional misstatement in financial statements, including the omission of an amount, failure to fully disclose information, or a misstatement arising from theft of the entity's assets.

Fraud also involves:

• the use of deception such as manipulation, falsification, or alteration of accounting records or documents;
• misrepresentation or intentional omission of events, transactions, or other significant information; and
• intentional misapplication of accounting principles relating to amount, classification, manner of presentation, or disclosure.

28.4.4 Specific factors to consider when imposing gross negligence penalties

To determine if gross negligence penalties should be applied, consider (not an exhaustive list):

• materiality of the false statement or omission
• taxpayer’s history of contact with the CRA
• taxpayer’s knowledge of tax matters
• nature of the false statement or omission
• taxpayer’s involvement in preparing the return
• misinterpretation of the legislation
• books and records
• number of sources of taxable income
• disclosure of other sources of taxable income
• taxpayer’s history of compliance
• signature on the return

Materiality of the false statement or omission

The greater the materiality of the false statement or omission, the greater is the potential for gross negligence. However, the auditor cannot rely on materiality alone; sufficient audit evidence is required to establish gross negligence. For more information, go to 28.3.6, Burden of proof – Subsection 163(3) of the ITA.

Taxpayer’s contacts and known history with the CRA

Contacts and known history with the CRA that should have alerted the taxpayer that more care should be taken in completing and filing returns. This may entail a complete review of the return being adjusted, as many prior year returns as possible, and any relevant information in the trailing documents, including the former permanent document (PD) folder, stored with Iron Mountain (IRM). This review could indicate that a similar adjustment has previously been made and that the taxpayer has been warned that a recurrence could result in a penalty. The review may also indicate that the taxpayer was previously penalized.

Taxpayer’s knowledge of tax matters

The auditor should be sure that the taxpayer couldn’t reasonably claim that the false statement was made innocently and unintentionally. Therefore, evaluate the taxpayer’s general knowledge and education, as well as specific knowledge of the ITA, of their income, and of the books and records.

Nature of the false statement or omission

The nature of the false statement: for example, would the omission or false statement have been obvious to a taxpayer exercising usual care in the preparation of a return or other document for the purposes of the ITA? When a major shareholder’s return is reassessed, the auditor should keep in mind that a majority shareholder usually controls their income from the corporation and consequently, should be aware of the amount of income from this source.

Taxpayer’s involvement in preparing the return

The degree of the taxpayer’s involvement in maintaining the books and records and in preparing returns and other documents required by the ITA, as well as the taxpayer’s awareness of the relationship between the records and the amounts reported, are important considerations to determine if penalties are applicable.

A taxpayer that examines the return before signing and filing it and keeps adequate records should usually be aware of any significant false statements. The assessment of a penalty can be more readily justified when it can be demonstrated from the records and interviews that the taxpayer participated in all the tax planning or preparation of returns required by the ITA. On the other hand, the application of the penalty may be appropriate even though the taxpayer failed to examine or understand the return, if there are sufficient other circumstances that support the application of the penalty.

Misinterpretation of the legislation

Generally, a penalty should not be imposed if there is a possibility of honest misinterpretation of the law by the taxpayer or genuine confusion as to whether an amount not reported was really taxable. Examples might include gains on the sale of real estate or securities by persons who were not clearly dealers.

Books and records

Consider a penalty whether or not the income omitted from the taxpayer’s return was recorded in the books.

On the other hand, a penalty is not usually warranted if the amount reported was understated, but the information supplied by the taxpayer, in or with the return, would suggest that the understatement was not deliberate.

In each case, the auditor must determine the adequacy of the taxpayer’s books and records. By not keeping proper books and records, the taxpayer has demonstrated a degree of neglect. If the auditor determines that the books and records are inadequate, the reasons must be documented. This information would form part of the case for the application of a penalty.

In all instances where books and records are considered inadequate, an informal request or a requirement letter to keep adequate records should be sent to the taxpayer. For more information, go to 10.2.0, Books and records.

Number of sources of taxable income

The greater the number of similar sources of taxable income, the more plausible it becomes that one source was inadvertently omitted. Also, when the taxpayer has many different sources of taxable income, one may have been overlooked.

Disclosure of other sources of taxable income

The omission of some source of taxable income by a taxpayer who voluntarily discloses some other source for which there is no invoice, information slip, or relationship with a third party might not be, depending on the circumstances, an omission committed as a result of the taxpayer’s gross negligence, particularly if the amount omitted is less than the amount voluntarily reported.

Taxpayer’s history of compliance

When the taxpayer has usually filed returns in a timely manner, made remittances, payments, and instalments on time, there is a presumption that the person has acted responsibly and with a degree of care in tax matters. Consider this when deciding if a penalty should be applied.

Signature on the return

A taxpayer demonstrates negligence by signing a return without first ensuring that the information reported is accurate and complete. However, this does not automatically make the taxpayer liable to a penalty for false statements or omissions; other audit evidence is required to support the assessment of penalties.

The fact that the taxpayer did not sign the return does not provide relief from the responsibility for its accuracy, unless the taxpayer can establish that it was prepared and submitted without their knowledge or consent. A taxpayer may be penalized even if a return is filed unsigned or if it is signed by someone else on behalf of the taxpayer, if other audit evidence supports the assessment of penalties.

As a general rule, attachments to the return, such as donation and medical receipts, T4 and T5 slips, copies of correspondence, and supporting schedules are sufficient audit evidence that the taxpayer intended that the return be accepted as prepared and filed.

In the case of returns filed electronically, a signed Form T183, Information return for electronic filing of an individual’s income tax and benefit return, is sufficient audit evidence that the taxpayer wanted the income tax return accepted as filed. The taxpayer must also electronically certify the completeness and accuracy of returns that are filed using NETFILE.

28.4.5 Situations where a gross negligence penalty is not imposed

As a rule, no penalty should be assessed if it is considered that there was a genuine misinterpretation of the ITA on the part of the taxpayer and it is reasonable to assume that the taxpayer did not know if:

• a particular source of income, such as the gain from sale of a capital property, was taxable; or
• a particular expenditure was deductible in computing taxable income.

A taxpayer will be given the benefit of the doubt and no penalty will be assessed in these situations:

• failure to report alimony and/or child support, or a pension for the first year in which these payments are received;
• income received by a spouse or common-law partner, but taxable in the hands of the taxpayer under section 74.1 of the ITA;
• taxable benefits, such as for the personal use of a company-owned vehicle and incentive bonuses that were not reported on a T4 or T4A slip, assuming the circumstances surrounding the failure to report the amount do not support the levying of a penalty;
• recent immigrants to Canada, particularly if there is an apparent language problem or the taxpayer received inappropriate advice from a third party;
• the taxpayer has just started working and the return is the first return filed; or
• the profit realized on an investment in treasury bills was reported as a capital gain rather than as interest income.

In these cases, or if a penalty was considered but not levied, advise the taxpayer in writing that consideration will be given to levying the penalty in subsequent years in the event of reoccurrence. This should be helpful in refuting a claim in later years that the taxpayer knew nothing of tax matters.

28.4.6 Taxpayer or agent’s responsibility

While the taxpayer is responsible for the accuracy of the returns filed under the ITA, the taxpayer has the right to hire an agent or representative to prepare them. The taxpayer will be held responsible for the representative’s errors and omissions, for penalty purposes, only to the extent that these should have been obvious to the taxpayer if reasonable steps were taken to ensure the accuracy of the return filed. If there are false statements made in the preparation of a return, auditors should consider the possibility of establishing gross negligence on the part of the taxpayer in spite of the involvement of an agent.

In Findlay, 2000 DTC 6345, the Federal Court of Appeal found that, in the circumstances, the gross negligence of outside experts was not attributable to the taxpayer. The case adopted the meaning of gross negligence set out in the Venne case, 84 DTC 6247 and approved the principles in Udell, 70 DTC 6019.

In Udell, 70 DTC 6019, a penalty under subsection 163(2) of the ITA was not assessed despite the fact that the accountant's conduct was deemed to constitute gross negligence. The court ruled that the taxpayer was not privy to the gross negligence of his accountant and that the taxpayer himself did not deliberately and intentionally make a false statement.

There should be enough audit evidence available that will show that the taxpayer either expressly knew or ought to have known of the false statements made by the agent and is therefore personally guilty of an offence under subsection 163(2).

• The auditor must obtain audit evidence that proves personal gross negligence on the part of the taxpayer.
• A taxpayer that summarizes income and expenses for an agent is aware of the income and therefore has sufficient knowledge to question a material mistake made by the agent in transposing from the summary to the return.
• The assumption by the agent of full responsibility for the incorrect return should not in itself be accepted as satisfactory audit evidence that the taxpayer was not guilty of gross negligence. For more information, go to 28.5.0, Third-party civil penalties.

In Howell v MNR, 81 DTC 230, the judge noted that the taxpayer is responsible for the accuracy of his return even though he hired an agent, that the taxpayer acted prudently by hiring an agent, and that there are other factors to be considered in determining responsibility for a false statement or omission:

"In an appeal where the question of "gross negligence" arises, the responsibility of a taxpayer for the accuracy of his own tax return is not eliminated by engaging a third party to prepare the return. Such professional help may be one point to be considered along with other factors such as the taxpayer's own conduct, competence and contact in the preparation of the return; the complexity of the return; the practicality of any review; and the extent of such review before filing. These considerations are not all-inclusive, but they are indicative of the objective basis and serious approach he may have taken to that responsibility, and the degree therefore to which any inadequacies therein should reflect upon him."

The agent is dependent on the taxpayer for the information necessary to file an accurate return. The taxpayer is therefore responsible for any false statements arising from a failure to make full and accurate information available to the agent. The auditor determines exactly what records were given to the agent to prepare the return and whether or not the agent was given sufficient information to prepare a proper return.

Cases will arise where the CRA is satisfied that certain errors or omissions were the result of gross negligence in the preparation of the taxpayer's return, but it is not clear if there was gross negligence on the part of the taxpayer, the agent, or both. If uncertainty exists, to determine whether or not gross negligence can be directly attributed to the taxpayer or if the taxpayer was aware of the agent’s gross negligence, consider:

• Is there anything available in writing to establish which of the parties was responsible for completing the applicable returns?
• To what extent was the taxpayer involved in the preparation of the return and supporting statements as well as the maintenance of the books and records? The more closely the taxpayer was involved, the more responsibility must be accepted for the accuracy of the returns.
• Did the taxpayer examine the return before signing and/or filing it? What are the details of any discussion that took place between the taxpayer and the agent at the time of filing the return?
• Was the taxpayer aware of the basis on which the agent was reporting income?
• Was the taxpayer knowledgeable about tax matters and to what extent was reliance placed on the representative?
• Was the taxpayer aware of (or should the taxpayer have been aware of) the amount of income earned? If so, what audit evidence supports that the taxpayer should have been aware of it?
• Does the taxpayer's education or contacts with the CRA indicate that they should have been aware of the degree of care that must be taken to file a proper return?
• What type of contract or understanding existed between the taxpayer and the representative? Was it an audit engagement or simply an agreement to prepare a return from summaries provided by the taxpayer? A taxpayer who contracted for an audit engagement is probably more entitled to rely on the agent's figures.
• Was there a long-standing relationship between the taxpayer and the representative? If so, the communication between them should be good so that they would know which questions to ask each other.
• Were the errors so obvious or material that the taxpayer should have noticed them if they cared at all about the accuracy of the representative's work? All taxpayers, even if they employ agents to prepare their returns, are usually responsible for seeing that no obvious items of income have been omitted. A sudden, unexpected, and substantial drop in net profit should cause any reasonable businessperson, regardless of a limited knowledge of accounting, to enquire as to the reason. If further verification discloses that such an enquiry would have uncovered the false statement, consider a gross negligence penalty.

If a representative was clearly negligent in preparing the taxpayer's return, consider thirdparty civil penalties and inform the taxpayer of the situation to ensure that it does not recur. For more information, go to 28.5.0, Third-party civil penalties.

If a particular representative continuously makes false statements in the preparation of a taxpayer's returns, consider referring such cases to Criminal Investigations to determine if the representative has engaged in fraudulent activity. It is mandatory to include a copy of all referrals and resulting reports in the audit file. For more information, go to 10.11.8, Referrals to the Criminal Investigations Division.

28.4.7 Minimum thresholds

Subsection 163(2) of the ITA – Under review

The Reassessment Program (RAP) system will reject reassessments when the federal penalty does not exceed $100 since the penalty cannot be less than $100 under subsection 163(2) of the ITA. The minimum provincial penalty is $100 ($150 for Newfoundland).

Previous reassessment for the same year

It sometimes happens that after a taxpayer has been reassessed without penalty, further discrepancies are discovered in the return, which makes it necessary to issue another reassessment and impose a gross negligence penalty. If it is clear that, had all the facts been known at that time, a penalty would have been levied for the previous reassessment, the penalty will be based upon the total adjustment, including any related adjustments on the previous reassessment.

28.4.8 Burden of proof

Under subsection 163(3) of the ITA, when a person appeals a penalty assessed under section 163 or 163.2, the burden of proof is on the minister.

It is not sufficient for the CRA to demonstrate only that there is a false statement or omission in the return. The CRA must also establish a set of facts that demonstrate that the person knew or ought to have known of the false statement or omission and that it was not the result of a simple oversight or a misunderstanding of the law.

The fact that a person agrees with the levying of penalties, does not relieve the auditor of the responsibility for justifying the penalties. Document well the person's admissions and obtain in writing if possible, or at the least, admissions made in the presence of another CRA officer.

If assessments are based in whole or in part on estimates, the auditor must ensure that the amounts are sound and reasonable (for example, based on the assessing net worth technique) and that the basis for each estimate can withstand the taxpayer's arguments. Make every effort to obtain the taxpayer's concurrence. In cases of doubt, the matter should be resolved in the taxpayer's favour.

The fact that a taxpayer has claimed an expense that has been disallowed on assessment of a return for a previous year or period, is not in itself sufficient audit evidence that the taxpayer knew that the return was wrong, even though the earlier reassessment may have been accepted without protest.

Audit evidence

Before considering the application of penalties, the auditor should be familiar with 10.5.0, Audit evidence.

Begin the gathering of audit evidence as soon as a possible penalty situation develops. Consider audit evidence not supporting the application of penalties as well as audit evidence in favour of a penalty. When a penalty is recommended, the audit evidence supporting the penalty must outweigh the audit evidence against it.

Interviews are essential in the preparation of a penalty case. Interview the taxpayer, the agent, or anyone whose testimony may be crucial and prepare a record of the interview at that time or shortly thereafter. These records form part of the documentary audit evidence, the importance of which cannot be overemphasized, particularly if the taxpayer makes an admission of guilt or if the file goes to Appeals or the Courts.

Documents or other audit evidence from competent witnesses, including the auditor, should demonstrate the facts that give rise to the imposition of the penalty. Usually, it is unnecessary to receive physical possession of audit evidence, unless:

• there is a danger that audit evidence essential to the case will be lost or destroyed before the expiry of the appeal date or subsequent hearing by the Tax Court of Canada or Federal Court; or
• there are areas where the taxpayer challenges the auditor's findings, and it is necessary to produce audit evidence to support the CRA's position.

In these cases, the auditor obtains a certified copy of all pertinent documents. All auditors are authorized under subsection 231.5(1) of the ITA to make certified copies. If it is not practical or possible to obtain a certified copy of pertinent documents, the auditor's working papers should accurately describe the audit evidence, including its location.

In no case is a penalty to be applied without the taxpayer first being advised in writing that a penalty is being considered. The Taxpayer Bill of Rights states that taxpayers have the right to complete, accurate, clear, and timely information. For a letter template, go to the Integras Template Library, letter A-11.1.7, Proposal letter with gross negligence penalty.

The auditor should try to rebut each point raised by the taxpayer for not applying the penalty. As well, the auditor must decide if the taxpayer's explanation is plausible and if it is consistent with the facts of the case.

The facts used to substantiate the penalty should be sufficient to rebut any assertion that the false statement in a person's return was made innocently and unintentionally, having regard to the taxpayer's business, profession, knowledge and experience in tax matters.

Penalty Recommendation Report

The proper preparation of a Penalty Recommendation Report is essential to all gross negligence penalty cases. The report is a complete summary of the facts and all statements in the report are supported in the working papers and other documents on file. It is a self-contained report enabling the reader to act on the auditor's recommendation without reference to other working papers.

This report and the auditor's working papers are to be in sufficient detail to ensure that the penalty has been properly applied and that if appealed, the auditor will be able to recall and identify documents and offer testimony about the records examined and the audit evidence uncovered justifying the imposition of a penalty. For more information, go to 11.6.2, Penalty Recommendation Report.

Approval of the Penalty Recommendation Report

The Penalty Recommendation Report must be approved by the assistant director, Audit (ADA), or by the delegated signing authority.

28.4.9 Net worth assessment – Under review

Consider assessing penalties in all cases where the assessing net worth technique, used as the main audit technique, reveals a substantial discrepancy in the taxpayer’s income. However, to assess penalties for each tax year covered by the net worth period, the discrepancy must be substantial in each of those years. The larger the portion of the net worth discrepancy represented by estimated personal expenditures, the more reliable those estimates must be. Any successful rebuttal of the estimates by the taxpayer could seriously affect the materiality of the net worth discrepancy. For more information, go to 13.4.0, Assessing net worth technique.

If there is a material discrepancy, and it is established that the books and records are not adequate, a potential gross negligence situation exists, but the auditor cannot rely on these facts alone. Consider the other criteria for the application of penalties.

While it is not necessary to prove suppression of income equal to the full amount of the net worth discrepancy, the auditor should try to obtain audit evidence indicating that a portion of the net worth discrepancy is the result of the omission of specific items of income and/or the deduction of certain fictitious expenses. Audit evidence of specific suppression in one or more years may serve as audit evidence of suppression for the other years covered by the net worth statement.

If the net worth discrepancy is substantial in relation to reported income, penalties may be imposed even though it has not been possible to establish specific items of suppression, if it is evident that the discrepancies could have resulted only from suppressed income. In preparing the assessing net worth statements, the auditor must take steps to establish:

• that there were no other sources of non-taxable income during the net worth period; and
• that there were no other assets, at the beginning of the net worth period, that could be used to explain the net worth discrepancy, such as cash-on-hand.

The auditor must also establish that the taxpayer knew or ought to have known that income was understated. Specifically identify the person or persons responsible for the entries to the records, for deposits, for cash control, etc. If it is determined that the taxpayer is primarily responsible for such activities and that they gave rise to the substantial understatement of income, this will assist the auditor in proving that the taxpayer, knowingly or in circumstances amounting to gross negligence, made a false statement or omission in a return. The taxpayer would usually be aware of income discrepancies determined by the assessing net worth technique, especially if there has been a major increase in:

• amounts deposited in bank accounts;
• term deposits or other short term investments;
• other assets, for example real estate and vehicles;
• investment income accompanied by a major decrease in debts; or
• the standard of living of the taxpayer without a similar increase in reported income.

In the case of a shareholder, the auditor should try to establish that the shareholder’s corporation is the only source of income. This refers to a taxpayer whose sole (apparent) source of income is salary and dividends from a corporation of which they are the major or sole shareholder.

Subject to the CRA policy concerning minimum limits for the levying of penalties, consider a penalty in every case where assessing net worth discrepancies have been established and the taxpayer has, in an earlier year, been advised in writing by the CRA to keep proper records to account for income.

If the net worth discrepancy is substantial and the auditor and team leader believe that gross negligence penalties can readily be assessed, refer the case to Criminal Investigations. It is mandatory to include a copy of all referrals and resulting reports in the audit file. For more information, go to 10.11.8, Referrals to the Criminal Investigations Division. Criminal Investigations will determine if the file is accepted for investigation of fraud.

28.4.10 Assessment based on unidentified deposits

If an assessment is based on unidentified deposits, consider levying a penalty under subsection 163(2) of the ITA. Auditors should exercise discretion if the taxpayer signs a statement indicating that the deposits in question in fact constitute income, as the burden of proof to support a gross negligence penalty rests with the minister and taxpayers may recant.

A penalty should only be levied if there is sufficient audit evidence to support the assessment without the taxpayer's statement. Furthermore, in all cases where the penalty is applied, there must also be sufficient audit evidence to support that a false statement was made “knowingly or under circumstances amounting to gross negligence.”

If there is insufficient audit evidence to support the assessment of unidentified deposits or there are indications that suppressed income is not limited to the unidentified deposits, the auditor must consider alternate means of verification, including the use of the assessing projections technique or the assessing net worth technique.

Cases supporting the imposition of penalties on assessments based on bank deposits include G. Stellmacher v Canada, 96 DTC 1422 and E. Kurbis v The Queen, 1998 (TCC) GST. For more information, go to 13.5.0, Assessing unidentified bank deposits technique.

28.4.11 Assessment based on the assessing projections technique

If an assessment or reassessment is based on a projection, consider levying a penalty under subsection 163(2) of the ITA.

A penalty should only be levied if there is audit evidence that is credible, well documented, and supportable, and is based on information that has been obtained from the taxpayer, third parties, or from expert opinion. Furthermore, in all cases where the penalty is applied, there must also be sufficient audit evidence to support that a false statement was made “knowingly or under circumstances amounting to gross negligence.”

An assessment based on the assessing projections technique should be restricted to those cases where the adjustments cannot be supported by factual audit evidence, the assessing net worth technique cannot quantify the unreported income, and the projection gives a reasonable basis for assessment or reassessment. For more information, go to 13.6.0, Assessing projections technique.

28.4.12 Suppressed income of a corporation appropriated by shareholders

Subject to the policy concerning minimum limits for the levying of penalties, if income of a corporation has been suppressed and a shareholder has used or has benefited from the funds or property that would otherwise have been received by the corporation, consider the application of penalties against both the corporation and the shareholder for each tax year involved. The sole exception to this policy is if appropriated funds or property are restored to a corporation by a shareholder under a voluntary disclosure, if the voluntary disclosure meets all the conditions set by the CRA. For more information, go to 3.3.0, Voluntary Disclosures Program.

The auditor must explain in both the corporation and shareholder files how the suppression of income was established. The mere statement that funds were appropriated is not sufficient.

28.4.13 Reopening statute-barred years

Under subsection 152(4) of the ITA, statute-barred years may be reassessed if there is misrepresentation that is attributable to neglect, carelessness, or wilful default. Neglect, carelessness, and wilful default require a lower degree of participation or knowledge of the misrepresentation than “gross negligence.” Therefore, statute-barred years may be opened when subsection 163(2) penalties have been considered, but not necessarily recommended, as long as the auditor can prove the “neglect, carelessness, or wilful default.”

For more information, go to 11.3.7, Assessment after the normal assessment or reassessment period and penalty for false statements or omissions.

28.4.14 For future use

28.4.15 Application of penalty in specific income tax situations

Disallowance of estimated personal expenses

Usually, penalties should not be levied on income tax increases resulting from the disallowance of the estimated personal portion of specific expense items, unless the audit evidence is clear that the taxpayer was aware or should have been aware that the claim was incorrect.

This applies only to expenses incurred partly to earn income and partly for personal reasons, such as the cost of operating a business vehicle that is also used for personal driving. It is not intended to apply to cases if expenditures, that are entirely personal, have been claimed as business expenses.

Disallowance of unvouchered expenses

If expenses are disallowed or reduced because of the lack of vouchers, penalties should not be levied, unless there is audit evidence that the expenses were either grossly or deliberately overstated. Make the distinction between a taxpayer who, in the absence of supporting records, simply estimates expenses in an amount greater than the auditor thinks is reasonable, and the taxpayer who claims fictitious expenses or total expenses that have been grossly overstated. Make this distinction even though the taxpayer was advised in prior years of the necessity of keeping books and records.

If the audit evidence does not clearly show that expenses were grossly or deliberately overstated, a penalty on the disallowed expenses should not be levied, unless the amount is material and the adjustment can be supported by a formal net worth statement. The assessing net worth technique establishes that there was unreported taxable income and that claiming of unvouchered expenses was one of the methods used by the taxpayer to understate income. Explain a decision to not prepare the assessing net worth (and to not penalize) on Form T20, Audit Report.

Taxable capital gains

The criteria for levying a penalty is equally applicable for unreported taxable capital gains realized on property acquired after 1971. Because of the difficulty in determining the valuation day value of a property acquired before 1972, consider penalties under subsection 163(2) of the ITA on unreported capital gains realized on such property only if gross negligence has been clearly established.

Subsection 110.6(6) denies a capital gains deduction if an individual has realized a capital gain on the disposition of capital property in a tax year and “knowingly or under circumstances amounting to gross negligence” fails to report the disposition on the return for that year or fails to file a return for that year within one year after the due date. The CRA is responsible for establishing the facts justifying the denial of the deduction.

Usually, a taxpayer’s reporting of a gain from the disposition of a particular property as a capital gain instead of income, is not considered a false statement and gross negligence penalties do not apply. In Robert E. Angus v The Queen, 96 DTC 1823, the judge made the following comments in disallowing 163(2) penalties on the portion of the reassessment relating to the capital gain:

“…but I have doubts about imposing a penalty for having shown the gains resulting from the disposition as being on capital account rather than on income account. That subsection refers to a false statement or omission in a return, not to a misrepresentation.”

Temporary deferment of income

Penalties are not ordinarily levied in isolated cases of understated income in one year followed by a corresponding overstatement of income in the following year. For example, a taxpayer reports income using the cash method of accounting, holds a cheque uncashed until after the end of the tax year, and reports the income in the following year when the cheque is transacted. However, a penalty will be considered if the taxpayer does this as a matter of practice and has previously been advised that the cheques are to be reported as income in the tax year that they are received.

Cases involving under-valued inventories and accounts receivable usually present difficulty in distinguishing between an honest difference of opinion and a deliberate attempt by the taxpayer to reduce income tax payable. Penalties should not be levied in such cases, unless the tax involved is substantial and there is clear audit evidence that the taxpayer intentionally understated reported income.

Capital cost allowance adjustments

If an increase in income is the result of disallowed or reduced capital cost allowance (CCA) claimed or the capitalization of depreciable assets written off as current expenses, penalties should not usually be levied, unless there is reasonable audit evidence that the taxpayer knew they were making an improper claim and had taken steps to conceal this fact.

For example, consider a penalty if a taxpayer had a supplier backdate an invoice to claim CCA on an asset delivered after the end of the tax year. Another example is if the taxpayer tries to conceal the fact that depreciable assets have been claimed as current expenses by allocating the cost among several expense accounts or by misrepresenting the nature of the amounts written off.

However, before penalties are levied, the auditor must ensure that the assessment is technically correct and there must be no possibility of an honest misinterpretation of the law by the taxpayer.

Loans to shareholders

An increase in income tax resulting from the application of subsection 15(2) of the ITA does not usually give rise to gross negligence penalties, unless all these circumstances are present:

• There is no doubt that the taxpayer was aware of the shareholder loan provisions.
• The taxpayer has not repaid a significant portion of the debt.
• The taxpayer has misrepresented or has caused the corporation to misrepresent the status or nature of the loan.

28.4.16 Application of gross negligence penalty to Scientific Research and Experimental Development claims

Scientific Research and Experimental Development (SR&ED) claims involve a complex area of the income tax law and require determinations (usually by an expert) of both fact and opinion.

28.4.17 Calculation of the penalty for false statements or omissions

The 163(2) penalty calculation, as stated in the ITA, can be quite complex, taking into account the effect of many tax credits. For simplicity, this document will focus on the main penalty calculation under paragraph (a).

A penalty can be assessed solely on the overstatement of a refundable tax credit under paragraphs 163(2)(c) through (g). As the penalty calculation presented in this document is limited to paragraph (a), it is necessary for an auditor to perform further technical research if these items are involved in the subject income tax return:

• Clauses 163(2)(a)(i)(B) and (ii)(B): Special tax abatement for some Quebec residents – Subsection 120(2);
• Clauses 163(2)(a)(i)(B) and (ii)(B): First Nation’s tax – Subsection 120(2.2);
• Paragraph 163(2)(c): Overstatement of the Canada Child Benefit – Section 122.6;
• Paragraph 163(2)(c.1): GST/HST credit – Section 122.5;
• Paragraph 163(2)(c.2): Refundable medical expense supplement – Subsection 122.51(2);
• Paragraph 163(2)(c.3): Working income tax benefit – subsection 122.7(2);
• Paragraph 163(2)(c.5): School supplies tax credit – subsection 122.9(2);
• Paragraph 163(2)(d): Refundable investment tax credit – Subsection 127.1(1);
• Paragraph 163(2)(e): Beneficiaries of income from a qualifying environmental trust – Subsection 127.41(3);
• Paragraph 163(2)(f): Canadian film or video production tax credit – Subsection 125.4(3); and
• Paragraph 163(2)(g): Film or video production services tax credit – Subsection 125.5(3).

The penalty under subsection 163(2)(a) of the ITA is determined with reference to the amount of tax that would be payable on the understatement of income tax deemed to be paid on account of tax. The penalty is calculated as the greater of $100 and 50% of the net additional income tax payable (after deducting the applicable tax credits not attributable to the gross negligence) that is reasonably attributable to the false statement or omission.

Understatement of income

Understatement of income is defined in subsection 163(2.1) of the ITA. Under paragraph163(2.1)(a), it is the unreported income less any previously undeducted allowable expenses that relate directly to the generation of the unreported income subject to the subsection 163(2) penalty (that is, wholly applicable).

Under paragraph 163(2.1)(b) of the ITA, the entire amount of any other overstated expenses will be calculated in the “overstatement amount”. No offset will be allowed for additional expenses, such as additional capital cost allowance. Although included in the “overstatement amount,” penalties will only apply to the portion that is reasonably attributable to the false statement or omission.

Subsection 163(2.1) deems, for the purposes of computing the penalty under subsection 163(2), that the taxable income reported cannot be less than nil. Therefore, a penalty may be levied regardless of the fact that the additional income would not otherwise result in any tax. Further, there will be cases where the tax amount on which the penalty was calculated is completely different from the amount of tax assessed as shown by the notice of reassessment, due to the fact that offsets are allowed in computing taxable income, which are not considered in computing amounts subject to penalties.

Further, under paragraph 163(2.1)(c), any overstated deductions to arrive at taxable income are included as an “understatement of income” for subsection 163(2) calculations. Overstatement of section 111 deductions for losses is specifically excluded, therefore eliminating any double penalty on losses carried forward or backward.

Net federal income tax payable

The net federal income tax payable is the tax payable by an individual for the year, including the tax payable under Part I.2 (social benefits repayment) and reduced by the following amounts:

• applicable tax credits;
• refundable Quebec allowance as set out in subsection 120(2) of the ITA; and
• individual’s income tax payable to an Aboriginal government under subsection 120(2.2) of the ITA.

With reference to the above, the amounts that are subject to penalty under subsection 163(2) of the ITA are:

• disallowed tax credits that are reasonably attributable to the false statement or omission; and
• the net federal tax payable on the “understated income” determined without considering additional discretionary tax deductions claimed and considering the non-discretionary deductions.

Tax credits

To calculate the notional tax payable to determine the 163(2) penalty to be levied in a loss year, deduct tax credits, such as the investment tax credit. Consider tax credits, including those earned in subsequent years and eligible for carry-back to the particular year if the returns of those subsequent years were already filed at the time of the penalty calculation. Note however, that tax credits notionally deducted for purposes of calculating the penalty remain available for application in other years and the tax credit pools are not reduced.

Overstatement of tax credits

A penalty can be assessed solely on the overstatement of a tax credit. Paragraphs 163(2)(c) through (g) of the ITA provide for penalties on the:

• Canada Child Benefit – Section 122.6;
• GST/HST credit – section 122.5;
• refundable medical expense supplement – subsection 122.51(2);
• refundable investment tax credit – subsection 127.1(1);
• beneficiaries of income from a qualifying environmental trust – subsection 127.41(3);
• Canadian film or video production tax credit – subsection 125.4(3); and
• film or video production services tax credit – subsection 125.5(3).

Example of gross negligence penalty calculation

The facts:

• A $20,000 loss is reported on the taxpayer’s 2011 return in respect of a sole source of income, resulting in a non-capital loss of $20,000.
• The taxpayer applied the $20,000 loss to income for 2010, reducing taxable income for 2010 to $5,000.
• Following an audit, the taxpayer’s 2011 income was increased by $30,000, with the result that the $20,000 non-capital loss becomes income of $10,000. The loss carryover was disallowed following an adjustment to income for 2011. The taxable income for 2010 is therefore revised to $25,000.
• Gross negligence penalties are being levied under subsection 163(2) of the ITA.

Note: The taxpayer pays income tax on the revised taxable income of $25,000 in 2010, but there is no penalty for that year.

28.4.18 Other gross negligence penalties

While gross negligence penalties are most frequently applied for an income tax return, the ITA specifically provides for penalties as result of false statements or omissions in several information returns and prescribed forms as follows:

For more information, go to:

• Form T101, Statement of resource expenses
• T106 - Audit Guide (including Database Guide) & Reference Manual (HQ1073-000-R) and
• Form T106, Information return of non-arm’s length transactions with nonresidents

For more information about Forms T1134, T1135, T1141, and T1142, go to Foreign Reporting.

28.4.19 References – Penalty for false statements or omissions

Case law

Knowingly/gross negligence

• D. Comptois et al. v The Queen, (TCC) 1998
• Snelgrove v MNR, (TRB) 1979
• Lucien Venne v The Queen, (FCTD) 1984
• Lloyd V. Johnson v MNR, (TCC) 1990
• Howell v MNR, (TRB) 1981,
• MNR v Weeks, (FCTD) 1972
• Mark v MNR, (TRB) 1978
• Morgan et al. v MNR, (TRB) 1973

GST/HST

• Alex Excavating Inc. v The Queen, (TCC) 1995
• FBF Limited v The Queen, (TCC) 2000
• K T Swimm v The Queen, (TCC) 1996
• 897366 Ontario Limited v The Queen, (TCC) 2000
• P L Construction Ltd. v The Queen, (FCA) 1998
• 410812 Ontario Limited v The Queen, (TCC) 2002

Capital gains and capital gains deduction

• Robert E. Angus v The Queen, (TCC) 1996
• Colangelo et al. v The Queen, (TCC) 1998
• Carlson v The Queen, (TCC) 1997
• Ian Joseph Findlay v The Queen, (FCA) 2000
• Gerald Malleck v The Queen, (TCC) 1997

Net worth assessments

• G. Miucci v The Queen, (TCC) 1995
• Hildebrandt v The Queen, (TCC) 1997
• Nancy Kerr v The Queen, (FCTD) 1989
• Boileau v The Queen, (TCC) 1989

Disallowance of expenses

• P. Ng v The Queen, (TCC) 1998

Income Tax Information Circulars

• IC00-1R6, Voluntary Disclosures Program
• IC01-1, Third-Party Civil Penalties
  

28.4.20 Provincial and territorial income tax provisions regarding gross negligence penalties

28.5.0 Third-party civil penalties

Third-party civil penalties are provided for in section 163.2 of the ITA. The provisions are directed to persons, other than the taxpayer, who have made representations that result in false statements or omissions on the taxpayer’s returns. There are two penalties generally referred to as the planner penalty (subsection 163.2(2)) and the preparer penalty (subsection 163.2(4) of the ITA).

The third-party civil penalty provisions evolved primarily from a need to deter tax shelter or tax shelter-like promotions with inflated asset values and faulty assumptions. They are also intended to deter those persons who counsel or assist others in filing false returns as well as those who ignore false information submitted by taxpayers for tax purposes.

Third-party penalty provisions came into effect on June 29, 2000. For more information, go to:

• Income Tax Information Circular IC01-1, Third-Party Civil Penalties
• Third-Party City Penalties

28.6.0 Penalties for late-filed and/or amended elections under the ITA

28.6.1 Section 85 rollovers

The election when a property is transferred to a taxable Canadian corporation by a taxpayer under subsection 85(1) of the ITA or by all the members of a partnership under subsection 85(2), allows the transferor to defer the reporting of some or all of the gain that would otherwise arise on such a transfer.

A taxpayer can file the election after the prescribed filing date, amend or revoke a previous election, if certain conditions are met, including the payment of a penalty:

1. Elections filed not later than three years after the filing due date:

Under subsection 85(7), elections filed up to three years late will be accepted if the following conditions are met:

• the election is made in prescribed form; and

• the taxpayer or partnership pays an estimate of the penalty in respect of the election when the late election is filed.

2. Elections amended or filed more than three years after the filing due date:

Subsection 85(7.1) authorizes the minister to accept as valid, amended elections filed at any time, or elections filed more than three years after the filing due date, if, in the opinion of the minister, it is “just and equitable” to accept these elections if the following conditions are met:

• the amended or late election is made in prescribed form; and

• the taxpayer or partnership pays an estimate of the penalty in respect of the amended or late election when that election is filed.

The authority to accept elections filed under subsection 85(7.1) is delegated by the minister to the directors of the TSO under the ministerial authorization on the delegation of powers, duties, and functions.

The CRA considers that accepting an election is just and equitable when the requirements of the section relating to that election have been met and no attempt at tax evasion or fraud has been established.

The transferor will also have to submit a written request to the minister asking that the transferor’s election be accepted. This request will have to include the reasons why the taxpayer believes that it would be just and equitable for the election to be accepted.

When a taxpayer sends a letter to the CRA requesting an amendment to the original election and is subsequently informed that an amended election is necessary, the election will be considered as having been filed on the date on which the letter was received for the purposes of calculating the penalty.

Description of the penalty

The penalty set out in subsection 85(8) of the ITA is the lesser of:

• 0.25% of the amount by which the property’s fair market value at the date of disposition exceeds the agreed amount, for each month or part of a month from when the election was required to be made until it was filed or amended; and
• $100 per full or part month referred to above, to a maximum of $8,000.

Guidelines – Payment of the penalty

The penalty is assessed under subsections 85(7) or 85(7.1). This penalty is not discretionary. The transferor must pay an estimated penalty when the election is made and the CRA will subsequently determine the balance of the penalty that the transferor must pay. When the estimated amount of the penalty is not paid on the date the election is filed, the taxpayer will be advised that the election will not be processed until the estimated penalty has been paid.

References – Section 85

• Income Tax Information Circular IC76-19R3, Transfer of Property to a Corporation under Section 85
• Income Tax Folio S4-F3-C1, Price adjustment clauses
• Income Tax Information Bulletin IT291R3, Transfer of Property to a Corporation under Subsection 85(1)

Penalties for late and/or amended elections – Other rollovers

The CRA extends its position on the late and amended election provisions under subsection 85(1) to the similar provisions relating to other “rollovers” or transfers of property.

Dispositions of shares in a foreign affiliate

Subsection 93(1) of the ITA contains numerous rules about the disposition of shares of a foreign affiliate of a taxpayer resident in Canada. Subsection 93(1) permits a corporation resident in Canada to elect to treat the proceeds of disposition of such shares as a dividend. Provisions regarding late elections and related penalties similar to those in section 85 are contained in section 93.

Disposition of property to a partnership

Subsection 97(2) of the ITA provides rules for the tax-deferred transfer of capital property, eligible capital property, resource property, and inventory to a partnership if all the partners jointly elect to do so. Provisions regarding late elections and related penalties, similar to those in section 85, are contained in section 96 as follows:

Partnership ceases to exist and property distributed to members

Subsection 98(3) of the ITA allows the members of a partnership that has ceased to exist to elect to transfer all the partnership property to themselves on a tax-deferred basis. Provisions regarding late elections and related penalties similar to those in section 85 are in section 96 as follows:

For more information, go to:

• Form T2057, Election on disposition of property by a taxpayer to a taxable Canadian corporation;
• Form T2058, Election on disposition of property by a partnership to a taxable Canadian corporation;
• Form T2059, Election on disposition of property by a taxpayer to a Canadian partnership;
• Form T2060, Election for disposition of property upon cessation of partnership; and
• Form T2107, Election for a disposition of shares in a foreign affiliate.

28.6.2 Late-filed capital dividends election

A private corporation may elect, under subsection 83(2) of the ITA, to deem a dividend that is payable to shareholders of any class of shares to be a capital dividend paid out of its capital dividend account. No part of the capital dividend is included in the recipient’s income.

An election to pay a capital dividend should be filed on Form T2054, Election for a capital dividend under subsection 83(2), by the earlier of the day the dividend becomes payable and the first day any part of the dividend is paid.

Under subsection 83(3), a late-filed election will be accepted, if it is made in prescribed manner and the corporation pays the estimated penalty in respect of the late election when the election is made. The estimated penalty is calculated under subsection 83(4) as the lesser of:

• 1/12th of 1% of the amount of the dividend; and
• $41.67.

multiplied by the number of months and part months between the date the dividend was paid or became payable, whichever is earlier, and the actual filing date.

Under subsection 83(3.1), the late-filing provisions cease to apply for a particular dividend if a taxpayer does not comply with the CRA’s written request to make a late election, for that dividend, within 90 days of service of the request.

Amended or revoked elections

A taxpayer who wishes to amend or revoke an election made within the prescribed time under subsection 83(2) of the ITA may make an application to that effect under the taxpayer relief provisions set out in subsection 220(3.2). When the minister allows an election to be amended or revoked, the corporation is liable to a penalty under subsection 220(3.5).

For more information, go to Income Tax Folio S3-F2-C1, Capital Dividends.

28.6.3 Taxpayer relief provisions – Late, amended, or revoked elections

In accordance with subsection 220(3.2) of the ITA, the minister may, on application, extend the time for making, or grant permission to amend or revoke, an election by a taxpayer or partnership, which is listed in Part VI of the Regulations.

However, the taxpayer is liable to a penalty in respect of the amended, revoked, or late election. When the minister accepts the application to extend the time to file, or to amend or revoke an election, the taxpayer or partnership is liable to a penalty under subsection 220(3.5) equal to the lesser of:

• $8,000; and

• $100 times the number of complete months that have elapsed between the expiry of the deadline for making the election and the date on which the application was made.

The Taxpayer Relief Procedures Manual has complete and up-to-date policies and guidelines on how to apply the taxpayer relief provisions, including the provision for accepting late, amended, and revoked elections. For more information, go to:

• Taxpayer Relief Procedures Manual
• 3.0, Taxpayer rights and taxpayer relief
• Income Tax Information Circular IC07-1R1, Taxpayer relief provisions

28.7.0 Failure to deduct, withhold, collect, remit, or pay an amount

28.7.1 Failure to deduct or withhold an amount – ITA

Every person who, in a calendar year, has failed to deduct or withhold an amount of tax from a payment to a Canadian resident, as required by subsection 153(1) of the ITA, or to a nonresident under section 215 of the ITA, on account of the payee’s tax, is liable to a penalty under subsection 227(8) of the ITA.

The payments subject to withholding include virtually any amount that is usually subject to tax in the recipient’s hands in accordance with either Part I or Part XIII of the ITA, including salaries and wages, superannuation, pension payments, dividends, interest, and payments out of various registered plans.

The penalty is 10% of the amount that should have been deducted or withheld for the first failure in a calendar year to deduct or withhold such an amount. A second-tier penalty of 20% of the amount not deducted or withheld is imposed where, at the time of the failure, a penalty had previously been assessed under subsection 227(8) during the same calendar year and the failure to deduct or withhold was made knowingly or in circumstances amounting to gross negligence.

28.7.2 Failure to remit an amount withheld – ITA

Every person who, in a calendar year, has failed to remit or pay the following amounts is liable to a penalty under subsection 227(9) of the ITA:

• an amount deducted or withheld as required by the ITA or a regulation; or
• an amount of tax that the person is required to pay by section 116 or by a regulation made under subsection 215(4).

Subsection 227(9) provides for a graduated rate and a two-tier penalty. On the first occurrence in a calendar year if:

• payment is made by the date due, but not in the manner required, the penalty is 3% of the amount;
• payment is made 1-3 days after the date due, the penalty is 3% of the amount;
• payment is made 4-5 days after the date due, the penalty is 5%;
• payment is made 6-7 days after the date due, the penalty is 7%;
• payment is made more than 7 days after the date due, the penalty is 10%.

Where there is a second failure within the calendar year and that failure was made knowingly or under circumstances amounting to gross negligence, the penalty is 20% of the amount.

First $500 exempt from penalty

Subsection 227(9.1) of the ITA restricts the application of the penalty contained in subsection 227(9) for late or deficient remittances to the amount by which the total required to be remitted under subsection 153(1) and under the Canada Pension Plan and Employment Insurance Act for the particular period exceeds $500. This $500 threshold does not apply if the person knowingly or under circumstances amounting to gross negligence was late in remitting or has remitted less than the required amount.

The $500 exemption does not apply for tax deducted or withheld under subsection 215(1) of the ITA from payments made to non-residents.

Application policy – Unremitted amounts

1st delay: Standard warning.

2nd delay: First-tier penalty at 3% to 10%, less the $500 exemption under subsection 227(9.1) of the ITA.

3rd and subsequent delays during the same calendar year: Second-tier penalty at 20%. The $500 exemption is not applicable since the person, knowingly or in circumstances amounting to gross negligence, delayed remitting the amount or remitted an amount less than the amount required to be remitted.

For more information, go to Income Tax Information Circular IC77-16R4, Non-Resident Income Tax.

28.7.3 Directors’ liability – Failure to deduct or remit income tax

The provisions of subsection 227.1(1) of the ITA clarify that directors of the corporation, at the time that it was required to deduct, withhold, remit, or pay certain amounts of money held in trust for the Crown, are jointly and severally liable, together with the corporation, to pay any such amount plus any related interest and penalties.

Consequently, if an amount is not deducted and remitted, the directors are liable for the amount if they are classified as inside directors, outside directors, titular directors, nominal directors, or otherwise, and regardless of their degree of participation in the day-to-day operations of the corporation. [MacDonald v The Queen, 1998 4 CTC 2067, paragraph 83].

A director is not liable for such an omission if the degree of care, diligence, and skill to prevent the failure was exercised that a reasonably prudent person would have exercised in comparable circumstances.

For more information, go to Income Tax Information Circular IC89-2R3, Directors’ Liability.

28.8.0 Miscellaneous penalties

28.8.1 Unfounded appeal

Section 179.1 of the ITA, provides that the Tax Court of Canada may impose a penalty, on application from the minister, when a person instituted an unsuccessful appeal of a CRA decision and the Court determined that there were no reasonable grounds for the appeal. The Court must be of the opinion that one of the main purposes for instituting or maintaining the appeal was to defer the payment of income tax. The penalty is an amount not exceeding 10% of the amount that was in controversy and which the Court found was without reasonable grounds for appeal.

28.9.0 Penalties under the transfer pricing provisions

Transfer prices are the prices at which services, tangible property, and intangible property are traded across international borders between related parties.

The penalty assessed under subsection 247(3) of the ITA applies to certain adjustments made under subsection 247(2) for taxation years and fiscal periods that begin after 1998. Where a Canadian taxpayer or partnership, and a non-resident person with whom the taxpayer or partnership does not deal at arm’s length, participate in a transaction or series of transactions, a transfer pricing adjustment will be made and penalties may be applied when the “transfer price” established by the taxpayer does not comply with the arm’s length principle.

The penalty will not be applied if the taxpayer made reasonable efforts to determine and use arm’s length transfer prices. A taxpayer who has a transfer pricing adjustment under subsection 247(2) and has not documented the transactions as required by subsection 247(4) will be liable to the penalty.

Generally, subsection 247(3) of the ITA, provides that a taxpayer is subject to a penalty for a taxation year equal to 10% of the total of the transfer pricing capital and income adjustments, minus, the amount for which reasonable efforts were made to determine a transfer price if that amount exceeds the lesser of $5,000,000 and 10% of gross revenue for the year.

If the transfer pricing capital and income adjustments exceed $5,000,000 or 10% of gross revenue for the year, the case must be referred by the TSO to the Transfer Pricing Specialty Section in the International Tax Division (ITD), International and Large Business Directorate, to consider penalties before a proposal letter is issued. A case officer in ITD will assist the auditor to determine whether to propose penalties. If penalties are proposed, the TSO must refer the case to the Transfer Pricing Review Committee at ITD for review. It is mandatory to include a copy of all referrals and resulting reports in the audit file.

For more information, go to:

• Income Tax Information Circular IC87-2R, International Transfer Pricing
• Communiqué ILBD-12-01, Referrals to the Transfer Pricing Review Committee

28.10.0 For future use

28.11.0 Due diligence – Cancellation or waiver of penalty

28.11.1 Background information

Black’s Law Dictionary defines due diligence as “such a measure of prudence, activity, or assiduity as is properly to be expected from, and ordinarily exercised by, a reasonable and prudent person under the particular circumstances; not measured by any absolute standard, but depending on the relative facts of the special case.”

The existence of a due diligence defence for penalties under subsection 280(1) of the Excise Tax Act (ETA) was first raised by the Tax Court of Canada in Pillar Oilfield Projects Ltd. v the Queen, [1993] G.S.T.C. 49, TCC, Court File No. 93-614 (GST)I, November 19, 1993. In his decision, Judge Bowman said that he would be acting contrary to the principles of fundamental justice and fairness if he were to refuse the right to use a defence of due diligence in respect of the penalties imposed under section 280 of the ETA.

In Consolidated Canadian Contractors Inc. v the Queen, (TCC) 1997, the Tax Court of Canada cancelled the penalty imposed under subsection 280(1) of the ETA because the appellant had shown due diligence. The subsequent appeal by the CRA to the Federal Court of Appeal (see Canada (Attorney General) v Consolidated Canadian Contractors Inc. (FCA, 1998)) was dismissed, as the FCA agreed with the TCC decision that a due diligence defence is available on the basis that the penalty imposed by subsection 280(1) gives rise to a strict rather than absolute liability.

Strict vs absolute liability

Strict liability offences allow a person to avoid liability for a penalty by proving that they took all reasonable care. This involves consideration of what a reasonable person would have done in the circumstances. The defence is available if the person reasonably believed, in a mistaken set of facts that, if true, would render the act or omission innocent, or if the person took all reasonable steps to avoid the particular event.

Absolute liability offences, on the other hand, do not allow taxpayers to absolve themselves by showing that they were free of fault. Absolute liability offences are those for which the legislative authority has made it clear that guilt would follow proof merely of the unlawful act.

Go to R v Sault Ste. Marie, [1978] 2 SCR 1299.

28.11.2 Due diligence – Section 233.5 of the ITA

Section 233.5 of the ITA, provides that the penalty under subsection 163(2.4) for omissions in Forms T1134 and T1141 is not applicable to taxpayers who made diligent efforts to obtain the omitted information.

For more information, go to:

• Form T1134, Information return relating to controlled and not-controlled foreign affiliates (2011 and later taxation years)
• Form T1141, Information Return in Respect of Contributions to Non-Resident Trusts, Arrangements or Entities

28.12.0 Cancellation and/or waiver of penalties under the taxpayer relief provisions

The taxpayer relief provisions permit the CRA to help taxpayers resolve problems that arise through no fault of their own. The provisions allow for a common-sense approach in dealing with those who, because of personal misfortune or other circumstances beyond their control, are unable to comply with a statutory requirement or have failed to pay or remit an amount when due. The taxpayer relief provisions allow the CRA to be more flexible and responsive to a taxpayer's circumstances when it would be unreasonable or unfair to penalize the taxpayer. For the pertinent legislation, go to subsection 220(3.1) of the ITA.

The taxpayer relief provisions are not intended, and must not be used, as a way to negotiate settlement of a taxpayer's account. In all circumstances, review taxpayer relief requests independently.

For more information, go to:

• 3.0, Taxpayer rights and taxpayer relief
• Taxpayer Relief Procedures Manual and
• Income Tax Information Circular IC07-1R1, Taxpayer relief provisions

28.13.0 For future use

28.14.0 Offences and penalties

28.14.1 Overview – Under review

The ITA, ETA, and the other acts administered by the CRA are regulatory statutes that provide for criminal sanctions. As with all regimes in the developed world, criminal sanctions are provided to ensure compliance by deterring fraudulent behaviour.

A number of provisions in the ITA provide for the imposition of criminal sanctions for serious breaches of the legislation. These provisions, which provide for the imposition of fines, or the imposition of fines and terms of imprisonment, apply in addition to fraud and other offences under the Criminal Code. Unlike civil penalties, which may be assessed by the minister and may be disputed by a taxpayer under the general assessment and appeal provisions, criminal breaches of the legislation must be prosecuted in the criminal courts and must be proven beyond a reasonable doubt.

If it appears that an offence has been committed, refer the matter to Criminal Investigations. It is mandatory to include a copy of all referrals and resulting reports in the audit file. For more information, go to 10.11.8, Referrals to the Criminal Investigations Division.

28.14.2 Summary of offences

28.14.3 Improper communication, use or disclosure of confidential information

For information concerning the following provisions, contact Legal Services’ Confidentiality Service Team.