7 October 1990 Income Tax Severed Letter - Tax penalty structure in Canada — a Revenue Canada paper

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.

Dear XXX

Enclosed please find the final version of our paper on the tax penalty structure in Canada. Ms. Sandra Farber will be attending the upcoming meeting of Working Party No. 8 to participate in the discussions on tax penalties.

If further information is required, please do not hesitate to contact us.

THE TAX PENALTY STRUCTURE IN CANADA

I. INTRODUCTION

• 1. The purpose of this note is to describe the structure and administration of Canada's tax penalty regime in the context of our self-assessment system of taxation.

II. BACKGROUND ON THE TAX SYSTEM

• 2. Canada has a self-assessment system for federal income taxes. Taxpayers file annual returns reporting their income, deductions and credits and calculate their taxes owing. The system also requires the filing of various information returns by either the payer of income or by certain classes of taxpayers and the remittance of tax throughout the fiscal year by payers of income who withhold tax and by those taxpayers who do not have tax withheld at source from a sufficient portion of their income. Revenue Canada, Taxation is responsible for administering the income tax legislation enacted by Parliament and for encouraging the voluntary compliance which is essential to our income tax system.
• 3. Remuneration paid to employees is subject to the withholding of tax at source. Employees file a statement with their employer indicating the amount of personal tax credits to which they are entitled for their dependants. The employer uses this information to deduct the correct amount of tax from remuneration payments.
• 4. Revenue Canada, Taxation provides employers with tax tables for use in calculating the tax to be withheld. If employees know that they will have significant expenses which will be deductible in computing their tax for the year in addition to their personal credits, they can apply to have their tax deducted at source reduced from the levels shown in the tax tables. This happens frequently in the case of taxpayers who must make alimony or child support payments or who contribute to tax assisted retirement plans.
• 5. Employers are required to remit the tax that they have withheld from their employees. Large employers (those who withhold more than $15,000 per month) must remit twice a month while small employers are required to remit their month's deduction by the 15th of the following month. Two months after the end of the calendar year, employers file returns reporting the amount of remuneration paid during the year and the amounts of tax deducted and remitted. A summary return is filed (T4 summary) along with information slips (T4s) for each employee. Each employee receives a T4 from his employer.
• 6. Tax may also be withheld at source from pension payments, unemployment insurance payments, certain lump sum payments out of retirement plans and other amounts of remuneration paid to non- employees. Payers of such remuneration are subject to remittance and reporting requirements similar to those for employers.
• 7. Individuals who have tax withheld at source from less than 75% of their net income, whose net federal tax payable for the current year exceeds $1,000, and whose federal tax payable for the immediately preceding year exceeded $1,000, must remit instalment payments of tax. These payments may be based on either the taxpayer's estimated tax payable for the current year, or on his or her actual tax payable in the immediately preceding year. In either case, tax credits and tax deductions at source would serve to reduce the individual's instalment requirement. Any remaining tax balance must be paid no later than April 30 of the year following the taxation year. Taxpayers who remit instalment payments are still required to file an annual income tax return.
• 8. Corporations are required to remit monthly instalment payments. These payments may be based on either: (a) the corporation's estimated tax payable for the current year; (b) the corporation's actual tax payable for the immediately preceding year; or (c) a combination of the corporation's preceding and second preceding years' tax payable. Annual returns of income (T2s) are required to be filed within 6 months of the end of the corporation's fiscal period. Any balance of tax owing must be paid either 2 months or 3 months after the end of its fiscal period depending on the nature of the corporation.
• 9. Partnerships are not subject to taxation at the partnership level. Partnership income is taxed in the hands of the partners who are subject to the remittance and reporting requirements described above. However, partnerships are required to file an information return.
• 10. Trusts are subject to taxation in respect of income not payable to beneficiaries in the year. They must file a return of income (T3) and information slips reporting amounts paid to beneficiaries within three months after the end of their fiscal period. Trusts also are required to make instalments on account of their tax in the same manner as individuals.
• 11. In addition to the information returns referred to above, payers of investment income (interest and dividends) are required to file returns (T5s) reporting amounts paid to investors. Each investor receives a T5. Payers of certain amounts to non-residents are required to deduct and remit tax.
• 12. Each taxpayer has a unique identity number. In the case of individuals, their social insurance number (SIN) is used whenever possible. Corporate taxpayers have another type of identifier. Employers who withhold tax at source have a separate number for this purpose.

III. THE PHILOSOPHY OF ADMINISTRATIVE PENALTIES

• 13. Administrative tax penalties serve as a deterrent and are levied to improve voluntary compliance. The development and administration of the tax penalty system should be guided by the principles of certainty and fairness.

IV. THE STRUCTURE OF ADMINISTRATIVE SANCTIONS

• 14. The administrative penalties prescribed by law fall within three categories: (1) failure to file an accurate return of income; (2) failure to withhold or remit tax when due; (3) failure to provide information returns.
• 15. The most severe administrative penalty is imposed where a taxpayer knowingly or in circumstances amounting to gross negligence participates in or makes a false statement or omission in a return, from, certificate, statement or answer. This penalty has recently been increased from 25% of the tax attributable to the false statement or omission to the greater of $100 and 50% of the tax attributable.
• 16. In situations not amounting to gross negligence, penalties are most severe for repeated failures to comply. For example, a repeated failure to report an amount in income attracts a penalty of 10% of the amount not reported.
• 17. Generally a single offence is subject to a single administrative penalty. However, some exceptions exist. A corporation which fails to file an information return reporting non-arm's length transactions between the corporation and a non-resident person is subject to a basic penalty. If the corporation is served with a demand for the information return and does not comply, it is liable for an additional penalty of $1,000 per month during which the non-compliance continues.
• 18. Where any administrative penalty has been assessed and is subsequently in issue as a result of an appeal, the burden of establishing the facts justifying the assessment of the penalty is on Revenue Canada, Taxation for penalties in respect of repeated failures to report an amount in income or in respect of gross negligence. The burden of proof in respect of other penalties is on the taxpayer.
• 19. Taxpayers may appeal the assessment of any administrative penalty in the same manner as they may appeal the amount of tax assessed. The first level of appeal is to the tax administration. If this proves unsuccessful, recourse can be had to the courts.

V. ABILITY TO APPLY, WAIVE AND ABATE ADMINISTRATIVE SANCTIONS

• 20. Currently, there is only specific legislative authority to waive administrative penalties with respect to failure to provide information on a prescribed form and failure to provide a Social Insurance Number. There are no other provisions in the Income Tax Act which specifically grant a power to waive or cancel properly levied penalties. The Financial Administration Act gives the Governor in Council the authority to remit any tax, fee or penalty when it is considered to be in the public interest. Revenue Canada, Taxation can sponsor a remission order but the decision-making power is not within our jurisdiction.
• 21. Internal policy permits properly levied administrative penalties to be waived or abated in certain circumstances. For example, if a taxpayer comes forward voluntarily to disclose a failure to file a return the only penalty applied is the penalty for failing to file a return together with interest. If a taxpayer voluntarily discloses an omission, there will be no criminal charges and the most severe administrative penalties for making false statements or omissions in circumstances amounting to gross negligence will not be applied. The guidelines for voluntary disclosure are available to the public and are attached.

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• 23. The lack of a general discretionary power does cause administrative difficulty on occasion. Often, the only way to provide relief to a taxpayer is by way of remission under the Financial Administration Act. Revenue Canada, Taxation is currently undertaking a study with a view to incorporating a legal power in the Income Tax Act to waive or abate penalties and interest in certain circumstances.
• 24. As discussed above, taxpayers have the same appeal rights under the Income Tax Act for administrative penalty assessments as are available for tax assessments. If the assessment of the penalty involved the exercise of discretion, Canadian law generally requires that any discretionary power be exercised on a reasonable basis. The authority exercising the discretion must examine the facts of each case and should not be bound by administrative guidelines.

VI. APPLYING ADMINISTRATIVE SANCTIONS

• 25. In practice, the administrative penalty most frequently applied is that for failing to file an income tax return as and when required. For the 1988 taxation year, this penalty was applied to 25,800 corporate returns and 143,180 individuals returns.
• 26. The administrative penalty for knowingly, or under circumstances amounting to gross negligence, making a false statement or omission in a return is infrequently applied. Several new penalties, such as the penalty for failing to file an information return with respect to transactions with related non-resident persons, have yet to be applied.

VII. APPEALS AGAINST ADMINISTRATIVE SANCTIONS

• 27. For the 1989 taxation year, the most frequently appealed administrative penalties were those for late filing, failure to deduct or remit income tax at source and making false statements or omissions in circumstances amounting to gross negligence.
• 28. Most penalty appeals are resolved at the administrative appeal level.
• 29. The typical cost for the taxpayer would depend upon whether the appeal was at the administrative appeal level or in the courts and whether the taxpayer was self-represented or incurring legal fees. Amounts paid by a taxpayer in respect of fees or expenses incurred in preparing, instituting or prosecuting an objection to, or an appeal in relation to an assessment of tax, interest or penalties are deductible in computing income.
• 30. In the two instances where discretion is contained in the legislation, a taxpayer could apply for judicial review of the exercise of the Minister's discretion.

VIII. STRENGTHS OF THE EXISTING ADMINISTRATIVE SANCTIONS SYSTEM

• 31. Most administrative penalties are based on clear, objective criteria to ensure uniform and consistent application. The lack of discretionary power in certain areas, such as with respect to penalties for late filed returns, eases administrative application and promotes equal treatment of taxpayers.
• 32. Multiple administrative penalties are usually not levied for the same offence but, a repeat offence can result in a more severe penalty. The recent introduction of graduated penalties is expected to contribute to increased taxpayer compliance.

IX. PROBLEMS ENCOUNTERED WITH THE EXISTING ADMINISTRATIVE SANCTIONS SYSTEM AND MEASURES TAKEN OR PLANNED TO REMEDY THEM

• 33. The lack of discretion to apply or abate administrative penalties is a weakness of the current penalty system. As mentioned above, this area is currently under study with a view to making recommendations for improvements.
• 34. Several changes designed to increase administrative penalties to a level more closely approximating those of other jurisdictions and to increase voluntary compliance were implemented in September 1988. The most significant aspect of this round of amendments was the introduction of two-tiered penalties to discourage chronic offenders.
• 35. In order to combat consistent underpayment of instalment payments, a new administrative penalty on late or deficient instalments was introduced for the 1990 and subsequent taxation years. This penalty is directed at individuals who significantly under remit and whose net instalment interest charged exceeds a minimum amount.

X. DISTINCTION BETWEEN INTEREST AND ADMINISTRATIVE SANCTIONS

• 36. Interest is charged on all amounts that are not paid when due whether they be unpaid tax, unremitted source deductions, deficient instalments or administrative penalties.
• 37. Interest rates are set quarterly based on the average yield of three month Government of Canada Treasury Bills which were sold during the first month of the previous quarter plus two percent.
• 38. Interest charges are compounded on a daily basis, from the date the debt was outstanding to the date of the payment.
• 39. While the rate of interest charged may, in some cases, be lower than that at which a taxpayer could borrow funds, the interest is not deductible for tax purposes either by those carrying on business or by those earning employment or investment income. To a taxpayer carrying on business, this is an important factor. The non-deductibility of interest charged on unpaid amounts could be viewed as an administrative penalty in and of itself.
• 40. The tax administration has no general authority to waive or abate interest charges. The remission order procedure described above is currently not available to remit interest alone since it is applicable only to tax, fees and penalties.
• 41. Both interest and administrative penalties can be assessed in respect of the same tax debt.
• 42. Interest is imposed on the penalty as well as on the tax amount.

XI. PENALTIES IMPOSED BY JUDICIAL AUTHORITIES

• 43. Judicial penalties may be imposed for various offences, including, failure to file returns, failure to respond to a demand for information, wilful evasion or attempt to evade payment of taxes and making a false or deceptive statement on a return. Judicial penalties, which are imposed only in connection with a criminal proceeding, involve either a fine, imprisonment, or both, depending on the criminal offence.
• 44. When there is an indication or suspicion of fraud, the audit division of Revenue Canada, Taxation will refer the case to the Revenue Canada, Taxation special investigations section. If the special investigations section concludes that the case presents a high probability of fraud, that section begins a criminal investigation.
• 45. Once the investigation has reasonable and probable grounds to believe an offence has been committed a meeting will be held to inform the taxpayer that a criminal investigation is underway with respect to particular taxation years. At that time the taxpayer will be given an explanation of their constitutional rights and the opportunity to provide information. This may take place prior to or at the time search warrants are executed to secure evidence in the case. The taxpayer is notified and given an opportunity to respond prior to the case being referred by the special investigations section to the Department of Justice. Charges for tax evasion are laid if the Department of Justice concludes that a case is sufficient to warrant criminal prosecution. A decision to lay criminal charges can be made by Revenue Canada, Taxation for less serious offences, such as failing to file a return as and when required.
• 46. The taxpayer's constitutional rights include the right to be secure against unreasonable search or seizure, the right to retain and instruct counsel upon arrest or detention and the right to be secure against self-incrimination.
• 47. Administrative and judicial penalties may be imposed on the same taxpayer for the same infraction. There is some question as to whether concurrent administrative and judicial penalties are contrary to the constitutional guarantee not to be punished for the same offence twice. To date, most courts have taken the position that as long as there is no overlapping of judicial penalties there will be no double jeopardy.
• 48. Appeal is available under the criminal appeal provisions of the Criminal Code.