Pursuant to subsection 163(2) of the Income Tax Act
Tax Foresight Primer Series
April 8, 2019
This article summarizes key principles, concepts, and considerations relating to gross negligence in the context of subsection 163(2) of the Income Tax Act ("ITA"): False statements or omissions. Click here to jump immediately to Tax Foresight's Gross Negligence Case Finder, search through over 480 cases dealing with subsection 163(2) and filter the results by outcome, court, year, factors relating to the taxpayer, tax preparer, tax return, and more. Click here to jump immediately to Tax Foresight's Gross Negligence Classifier for assistance in determining whether, on the specific facts of your client's situation, there have been circumstances amounting to gross negligence within the meaning of subsection 163(2).
Key Concepts Acquiescence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . False Statement or Omission . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Gross Negligence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
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Key Considerations in the Legislation and Case Law Sophistication of the Taxpayer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Characteristics of the Tax Preparer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Red Flags Calling for Further Inquiry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Actual Inquiries by the Taxpayer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Records . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
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Gross Negligence Primer 2
Subsection 163(2) of the Income Tax Act ("ITA")1 imposes a penalty on persons who have knowingly, or in circumstances amounting to gross negligence, made, participated in, assented to, or acquiesced in the making of false statements or omissions in their tax filings.
This primer focuses on the considerations relevant to the issue of whether there have been circumstances amounting to gross negligence that attract a subsection 163(2) penalty, not on whether there has been actual knowledge.
Subsection 163(2) is penal in nature and is reserved for taxpayers whose conduct attracts a high degree of moral blameworthiness. If the taxpayer had actual knowledge of the false statement or omission, this high degree of moral blameworthiness might be presumed. Otherwise, the subsection's penal nature explains why:
proving circumstances amounting to gross negligence requires a consideration of many factors which can include the taxpayer's education, sophistication, mental state, the circumstances of the preparation of their tax return, the specific characteristics and magnitude of the false statement or omission, whether they made reasonable inquiries when concerns became apparent and whether they kept accurate records. At even greater levels of specificity, the considerations can include whether the taxpayer was a new immigrant, had a functional grasp of English or French, was clinically depressed, tried to call the Canada Revenue Agency, or kept tidy source records. It could be said that the purpose of all these inquiries is to determine the degree of the taxpayer's moral blameworthiness in all the circumstances of their case. The more these considerations tend to point to a wrongful intention--the intention to evade tax or break the law--the more likely circumstances amounting to gross negligence will be found;
the Minister bears the burden of proving the elements justifying a subsection 163(2) penalty. The taxpayer bears the usual burden of proving that the Minister's assessment of the correct tax payable is wrong; and
while there is no express requirement in the ITA that a person who makes a false statement must intend or understand that this will result in tax savings before they can be found liable under subsection 163(2), if the tax savings were actually minimal or even non-existent, it tends to make it more difficult to establish that the taxpayer had the wrongful intention that should attract a gross negligence penalty.
An offence under subsection 163(2) does not necessarily require active participation. Passive acquiescence can suffice. Acquiescence can include not asking questions or raising any objections when such are warranted, or remaining satisfied with inadequate explanations for such statements.2
False Statement or Omission
A failure to report income is generally considered an omission. A false statement can include claiming an incorrect income, a non-existent loss, an improper deduction of expenses or an improper tax credit.
Gross negligence differs from ordinary negligence in that gross negligence is not just a failure to exercise reasonable care, but a failure to such a degree that it almost amounts to recklessness and is tantamount to intentional acting and an indifference as to whether the law is complied with or not. The considerations informing the analysis of whether there has been gross negligence can be organized into five general categories of inquiry:
1. the sophistication of the taxpayer;
2. if a third party prepared the tax returns, the characteristics of the tax preparer;
1R.S.C. 1985, c 1 (5th Supp), as amended. 2Such as in Schatz v. The Queen, 2006 TCC 474.
KEY CONSIDERATIONS IN THE LEGISLATION AND CASE LAW
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3. whether the content and circumstances of the tax return and its preparation raised "red flags" reasonably calling for inquiry;
4. what inquiries the taxpayer actually made following such "red flags"; and
5. the quality of the taxpayer's source records.
Not every line of inquiry will apply to all cases. No one consideration predominates. It is possible to find or reject gross negligence without considering every factor as long as the factors that are considered clearly point to the true intention of the taxpayer.
For example, gross negligence can be found if a taxpayer fails to make certain inquiries after becoming aware that there was a reasonable need for same--a case of willful blindness or deliberate ignorance, which could be said to attract moral blameworthiness, even if the taxpayer never prepared tax returns of their own and was a novice in such matters.3 On the other hand, gross negligence can be rejected if the taxpayer suffered from severe depression which affected her cognitive ability and for which the taxpayer probably ought not to be blamed, even when the taxpayer was found to have an understanding of tax concepts.4
Key Considerations in the Legislation and Case Law
Subsection 163(2) sets out the penalty for persons. Partnerships
and other entities are addressed at subsection 163(2.4) and fol-
The amount of the penalty is the greater of $100 or 50% of the
tax payable on the understatement of income related to the false statement or omission.5 The understatement of income cannot be
offset by the taxpayer's having an actual or supposed less-than-nil taxable income in the first place.6
The penalty under subsection 163(2) is an administrative one
and there is no Charter violation if it is levied even while the
taxpayer is also facing a criminal penalty under subsection 239(1) for tax evasion.7 But if a taxpayer is liable for a subsection 163(2)
penalty for a false statement or omission, he or she cannot also be
liable for a penalty under subsection 163(1) for the lesser offence of repeated failure to report income.8 The Minister bears the burden
of establishing the facts justifying the assessment of a subsection 163(2) penalty9 and the standard of proof is on a balance of probabilities,10 but if a taxpayer's conduct is consistent with two
viable and reasonable hypotheses, one justifying the penalty and
the other not, the benefit of the doubt must be given to the taxpayer and the penalty deleted.11
Considerations relevant to the gross negligence analysis can include the taxpayer's education level, fluency in English or French, language of the tax return, their work experience, mental health, whether they prepared their own tax returns, their relationship with their tax preparer, the obviousness and magnitude of the false statement or omission, whether they sought a professional second opinion, and whether they sought to change their returns upon concerns being identified. For your particular fact situation, the Gross Negligence Classifier can, in addition to predicting whether a court would find gross negligence subject to subsection 163(2), provide you with a list of cases having similar facts, sorted in order of similarity, as well as the leading authorities.
Sophistication of the Taxpayer
Generally, the more sophisticated the taxpayer, the more likely circumstances amounting to gross negligence will be found. The considerations informing the taxpayer's level of sophistication can be broken down into these subcategories as found in the reported cases:
4For example, in Torres v. The Queen, 2013 TCC 380. 4For example, in Rohani v. The Queen, 2009 TCC 88. 5Paragraphs 163(2)(a) to (g), inclusive. 6Subsection 163(2.1). 7Sommers v. MNR,  CTC 2451. 8Paragraph 163(1)(c). 9Subsection 163(3). 10Sommers, supra. 11Farm Business Consultants Inc. v. The Queen,  2 CTC 2450 (TCC), paragraph 27.
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Level of education. Depending on the nature and circumstances of the false statement or omission, a lack of formal education can tend to excuse a taxpayer from failing to recognize that something was amiss. The threshold is not very high. If the error is quite obvious, such as huge business losses for a non-existent business, then a taxpayer with basic numeracy and knowledge of business concepts such as profit and loss could be considered sophisticated enough to understand the need to question the legitimacy of such losses, even if he had not finished high school;12
Fluency in language of tax return. Where a taxpayer is not fluent in English or French, this factor can help give the taxpayer the benefit of the doubt, such as when the language barrier required the taxpayer to rely heavily on their tax preparer13 or when it caused a genuine misunderstanding of basic tax concepts.14 On the other hand, this factor can be easily outweighed by other considerations such as the taxpayer's business knowledge and experience and whether further inquiries ought to have been made;15
Business acumen of the taxpayer. Several factors speak to a taxpayer's business acumen and overall sophistication. These include experience being responsible for the finances of a business, working in a managerial or supervisory capacity, sitting on corporate boards, or owning, operating or controlling a business. The presence of such factors tends to tip the balance towards a finding of gross negligence;
Mental state. Medical conditions or other special circumstances that impact on a taxpayer's cognitive ability can lead the court to find that the taxpayer did not have the requisite mental state to be found morally blameworthy pursuant to subsection 163(2). Depression, alcoholism, and schizophrenia are among the situations considered in the reported cases.16
Characteristics of the Tax Preparer
Whether a taxpayer's reliance on a third-party tax preparer's advice can shield them from a subsection 163(2) penalty depends on considerations such as these:
if the tax preparer was a qualified accountant or had another relevant professional designation, this points away from gross negligence. The taxpayer could have been reasonably justified in trusting the tax preparer, especially if the tax preparer had prepared returns in previous years without issues for the taxpayer;17
if the taxpayer prepared his or her own returns in the past prior to using a third party, this tends to point towards gross negligence. It indicates the taxpayer had enough sophistication to detect errors and see the need for inquiry regarding the tax preparer's work;18
in the case of a fraudulent tax preparer, if their modus operandi included inserting false information into the tax return after the taxpayer signed, without the taxpayer's knowledge, this tends to point away from a finding that the taxpayer ought to be morally blameworthy for being duped, as long as the taxpayer was not relatively sophisticated. But another taxpayer with greater tax or business knowledge could well be expected, in the same situation, to have recognized the subtler signs that the tax preparer was a crook.19
Red Flags Calling for Further Inquiry
The cases have identified numerous "red flags," usually in the context
of tax filings prepared by fraudulent third party tax preparers. The red
flags are signs for taxpayers to make further inquiries or take some other No subsection 163(2) penalty
steps in order to show they did their due diligence before choosing to applied in approximately 60%
rely on the tax preparer's work. If, in the presence of these red flags, of the cases where the taxpayer
12For example, in Chenard v. The Queen, 2012 TCC 211. 15For example, in Murugesu v. The Queen, 2013 TCC 21.
lacked fluency in either English or French.
15For example, in Gorev v. The Queen, 2017 TCC 85, at paragraphs 15-18.
15For example, in Chenard, supra and Truong v. The Queen, 2017 TCC 22.
Where the taxpayer's work
16See, for example, Rohani, supra, Hyndman v. The Queen, 2004 TCC 64, and Cox v. Texhpe eQriueenecne, [20in02v]o2lvCedTC o2n50e6 (oTrCCa).
17For example, in Udell v. MNR,  CTC 704 (Ex Ct.). 18For example, in Brisson v. The Queen, 2013 TCC 235.
combination of responsibility for
19For example, in Anderson v. The Queen, 2016 TCC 93, paragraphs 48-56 and 83-89. business finances, supervising or
managing, sitting on a board of
directors, or owning, operating,
or controlling a business, gross
negligence was found about 70%
of the time.
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the taxpayer did not at least make reasonable inquiries, they could be found to have chosen to be willfully blind to the fraudulent scheme and therefore liable for gross negligence penalties. Red flags can be context-specific and can include but are not limited to:
a large order of magnitude of the false statements, such as significant losses that result in full tax refunds which are quite different from any previous tax years;
blatantness of the false statements that make them readily detectable, such as when the claimed losses are from businesses that are non-existent;
where the tax preparer refuses to complete the section of the tax return indicating that they and not the taxpayer prepared it;
where the tax preparer makes unusual requests, such as asking the taxpayer to sign the tax return with "Per" in front of their name;
where the tax preparer was previously unknown to most of the taxpayers or only introduced by word of mouth;
where the tax preparer provides incomprehensible explanations for the false statements or omissions;
where others warned against engaging the tax preparer, or the taxpayers themselves felt uneasy about telling others to do so;
where the tax preparer is to be compensated by a contingency fee, based on the amount of refund received;
where the taxpayer receives a tax receipt for more than three times the price he actually paid for an artwork that he never received and then supposedly donated.20
The extent and sophistication of a fraudster's scheme, which might include altering signatures and inserting information after the taxpayer signed the tax return, can obscure the "red flags." In that case, the taxpayer might be careless, naive, neglectful, or overly trusting, but not willfully blind such that he or she deserves the subsection 163(2) penalty.21
The relative complication of a tax return, such as one that had multiple changes from previous tax returns or multiple types of income, can also obscure the "red flags" of the magnitude or blatantness of the error or omission.22
Actual Inquiries by the Taxpayer
In circumstances where the taxpayer faced "red flags," examples of subsequent conduct tending to reduce their moral blameworthiness include:
asking the taxpayer's chartered accountant and professional financial advisor about a proposed charitable donation where the tax receipt amount was higher than the price paid and being given a green light;23
20These examples are from Torres, supra; Tomlinson v. The Queen, 2016 TCC 246, and Menard (Succession de) c. La Reine, 2004 TCC 431, paragraphs 25-26.
21As in Anderson, supra and in Therrien c. La Reine,  3 CTC 2141 (TCC). 22For example, in Hyndman, supra, the court accepted the argument that because the taxpayer's income was higher than usual in the year in question due to his retirement allowance, it did not strike him as obvious that it did not include the income from his exercise of stock options, which he had never received before either. The court also considered the taxpayer's alcoholism at the time. In contrast, in Panini v. The Queen, 2006 FCA 224, it was apparent the stock option income was missing from the total. Subsection 163(2) applied. 23For example, in Gardner v. The Queen,  2 CTC 2480 (TCC), paragraph 20.
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checking that a museum which was asking for donations actually was a registered charity;24
asking the taxpayer's chartered accountant about an income amount, receiving the assurance it would be taken care of and then relying on the accountant to do so;25
attempting to fix the concerns by filing adjustment requests with the Canada Revenue Agency;26 or
calling the consumer protection bureaus and Canada Revenue Agency to confirm that a proposed business venture had not been previously under investigation or was otherwise likely to bring trouble.27
After the Canada Revenue Agency has already contacted the taxpayer with concerns, subsequent cooperation and good faith communication--even just an attempt--can tend to show that the taxpayer did not have a wrongful intention in the first place.28
Such conduct does not necessarily absolve the taxpayer if, for example, the taxpayer has extensive business and accounting experience and cannot explain why inquiries were not made earlier, before the Canada Revenue Agency called.29 Nor will it help a taxpayer who, after making inquiries and receiving inadequate explanations, ought to have done something more but did not.30
When there is evidence of an understatement of income, an absence of source records or a failure by the taxpayer to keep adequate records tends to point towards a wrongful intention.31 Where the taxpayer has destroyed relevant records, the negative inference may be inescapable.32
Adequate record keeping for the purpose of analysing whether a subsection 163(2) should apply is, however, not necessarily a high bar. Depending on the circumstances, even if written source records are lacking, a subsection 163(2) penalty may not be appropriate if there exists evidence from other witnesses corroborating the taxpayer's version of events.33 In unusual circumstances where it might not be expected to keep records, their absence might not make a difference to the analysis.34
Just as a taxpayer cannot necessarily escape liability under subsection 163(2) by saying a third party prepared the tax returns, a taxpayer also cannot blame his or her accountant for recording amounts from receipts or other records improperly in circumstances where this ought to have been obvious to the taxpayer.35 If, on the other hand, a taxpayer provided accurate records and had no reason to doubt the correctness of the accountant's work, then this points away from a finding of gross negligence notwithstanding the accountant's subsequent errors.36
24Ibid. 25For example, in Gallery v. The Queen, 2008 TCC 583. 26For example, in Walker v. The Queen, 2011 TCC 10. 27For example, in Therrien, supra, paragraphs 18-19. 28See Anderson, supra, at paragraph 69 where a brief attempt to contact the Canada Revenue Agency was found to be "significant" in assessing the taxpayer's intention. In Hine v. The Queen, 2012 TCC 295 at paragraph 45, the taxpayer's cooperation and diligence in communicating with the Canada Revenue Agency once it had started its audit was similarly noted. 29For example, Holley v. MNR,  2 CTC 2152 (TCC). 30As in Schatz, supra. 31For example, subsection 163(2) penalties applied in Kim v. The Queen, 2016 TCC 150, where the cash balances recorded for the business did not match the bank deposits, the taxpayer kept no proper records for cash receipts, and the taxpayer provided no supporting documentation for any of his arguments or explanations. 32For example, in Thibault c. La Reine,  1 CTC 2555 (TCC), at paragraphs 44-47. 33For example, in Sandhu v. MNR,  CTC 2558, the taxpayer produced witnesses who testified to his business practices and gifts from his father. 34In Johnston v. The Queen,  2 CTC 2578 (TCC), the taxpayer who had a high school education took money from her employer under the guise of salary increases and was criminally convicted for fraud. She did not keep records of amounts she took from her employer and did not report them as income and this was understandable in all the circumstances (paragraph 17). She was still liable for subsection 163(2) penalties based on the magnitude of the amount taken in one of the years under review. 35For example, in Cocos v. The Queen, 2016 TCC 107, paragraphs 12-13 and 28-29, the accountant consistently deducted expenses in their entirety without adjusting for their significant personal component and this led to the inference that the taxpayer knew that misrepresentations attributable to gross negligence were being made in her tax returns. 36As in Udell, supra.
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In considering whether circumstances amounting to gross negligence pursuant to subsection 163(2) apply to a fact situation, one possible way to organize the analysis is in this order:
1. What was the effect of the false statement(s) or omission(s) on the tax payable? If it was minimal or nonexistent, might it be consistent with an explanation of mistake or simple, but not gross negligence?
2. What is the level of the taxpayer's sophistication? Did this impact his or her ability to understand basic business or tax concepts or otherwise impact his or her moral culpability? Tax Foresight's Gross Negligence Classifier can help you ensure you are considering all the criteria relating to taxpayer sophistication.
3. If the taxpayer relied on a third-party tax preparer, how morally blameworthy was that reliance in all the circumstances including but not limited to the third-party tax preparer's qualifications and previous work? Tax Foresight's Gross Negligence Case Finder can assist you in finding cases with similar facts for your analysis.
4. What "red flags" were discernible to the taxpayer during the process of preparing or finalizing the tax filing? If the taxpayer did not act on them, is there an explanation that reasonably points away from an intention to evade tax or an indifference to whether the law was being followed? Tax Foresight's Gross Negligence Classifier can help you ensure you are considering the most common "red flags" identified in the reported cases.
5. If, after seeing "red flags," the taxpayer made inquiries or took some other steps to address the concerns, did he or she do enough to show an intention to comply with the law and not to evade tax? Tax Foresight's Gross Negligence Case Finder can help you find similar cases for your analysis.
6. Do the taxpayer's own books and records match his or her version of events? If records are missing, is there other evidence that could fill in the gaps? Tax Foresight's Gross Negligence Case Finder can help you find similar cases for your analysis.
7. After considering all of the above, which of the applicable factors tend to point to a wrongful intention to evade tax as opposed to another explanation? How strongly do the factors point to a wrongful intention? Are both explanations equally supportable or does one explanation better tie all the factors together?
Gross negligence pursuant to subsection 163(2) of the ITA involves greater neglect
than just failure to use reasonable care. It involves a high degree of negligence
tantamount to intentional acting, an indifference as to whether the law is complied with or not. The courts look at multiple factors in assessing whether the taxpayer's conduct amounts to something tantamount to intentional acting or whether it can be inferred that the taxpayer was indifferent to complying with the law. No one factor is determinative nor are they equally weighed in all fact situations. The financial consequences of a subsection 163(2) penalty can be severe. A thorough review and analysis of the case law is imperative in preparing to advise your client.
Tax Foresight's Gross Negligence Classifier can assist you in determining, on
In over 70% of the reported cases on the issue of whether the taxpayer made a false statement or omission in circumstances amounting to gross negligence, the penalty applied.
your specific set of facts, whether circumstances amounting to gross negligence
exist within the meaning of subsection 163(2) of the ITA.
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Figure 1: The Gross Negligence Classifier report includes the specific questions and answers provided by the user that inform the predicted outcome. The information in this figure results in a prediction that the circumstances did not amount to gross
Gross Negligence Primer 8
Figure 2: The Gross Negligence Classifier result provides a confidence rating, an explanation, a list of similar cases, and a list of other important references (not shown). From this page, users can download a full report (depicted in part in
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