18 June 2010 Internal T.I. 2010-0356361I7 - Due Diligence Defence to a S. 163 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 a taxpayer is entitled to a due diligence defense when assessed a penalty under s. 163(1).

Position: Yes.

Reasons: The taxpayer took steps successfully to report the amount omitted; there being no failure to report an amount, the penalty should not have been assessed.

		June 18, 2010

	Ottawa Tax Services Office				HEADQUARTERS
									Income Tax Rulings
		  								Directorate
	Attention: Jean-François Houle 			Lindsay Frank
	Team Leader, Appeals Division				(613) 948-2227

									2010-035636

Due Diligence Defence Against the Imposition of a 163(1) Penalty

This is in reply to an email from Garry Prieur. At issue is whether a taxpayer is entitled to a due diligence defence against the imposition of a penalty under subsection 163(1) of the Income Tax Act, and whether the defence can be validly raised where the taxpayer was reassessed for unreported income in two consecutive taxation years.

The reassessments arose in respect of the 2004 and 2005 taxation years. The taxpayer was reassessed on February 24, 2006, in respect of a failure to report interest income for the 2004 taxation year. The subsequent reassessment of the 2005 taxation year on December 27, 2006, was prompted as a result of a request made by the taxpayer for an adjustment to include dividends into income. The 2005 taxation year was reassessed again on April 7, 2009 under subsection 246(1) in respect of a benefit conferred on the taxpayer and under subsection 74.1(2) for property transferred to a minor. Furthermore, a penalty was imposed under subsection 163(1) with respect to the earlier reassessment arising from the adjustment requested by the taxpayer. An objection has been filed against the imposition of the penalty.

Under subsection 163(1), a taxpayer, who fails to report an amount required to be included in income, and who had previously failed to report an amount in any of the three preceding taxation years, will be liable to a ten percent penalty in respect of the repeat failure. However, a taxpayer will not be penalised under subsection 163(1) if a requisite degree of due diligence can be demonstrated, see Dunlop v. The Queen, [2009] 6 C.T.C. 2223 (T.C.C.). To that end, the taxpayer must establish that he or she took reasonable precautions to avoid the event leading to imposition of the penalty, see Corporation de l'école polytechnique v. Canada, [2004] G.S.T.C 102 (F.C.A.). In other words, a taxpayer who, for a given year fails to declare an amount as part of income, will need to display greater vigilance to avoid a repetition in the three years following the first omission, see Giguère v. The Queen, [2007] 5 C.T.C. 2217 (T.C.C.).

In the instant case, it is clear that the taxpayer had demonstrated due diligence in respect of the first reassessment of the 2005 taxation year. It was the taxpayer, who recognised that he omitted to report a taxable dividend on his 2005 tax return assessed on December 27, 2006. Under the circumstances, it would not be reasonable to assess a penalty under subsection 163(1) when it was the taxpayer, who initiated the steps to rectify the omission. If the subsection 163(1) penalty were to be imposed, it would have to be in regards to the failure to report the benefit conferred and the transfer to the minor.

Should you have any questions or require additional information on the foregoing, please do not hesitate to contact Lindsay Frank at the telephone number provided above.

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

c.c. Garry Prieur
Appeals Officer
Ottawa Tax Services Office