Gross negligence penalties under ss. 163(2) of the Income Tax Act (Canada) (“ITA”) can be extremely onerous. The penalties may apply when taxpayers knowingly or in circumstances amounting to gross negligence make false statements or omissions in their tax filings and may equal 50% of the unpaid tax attributable to the false statement or omission. In Morton v The Queen, the taxpayer challenged substantial penalties for seeking to re-file for past taxation years to claim fictitious expenses. Morton’s unique legal arguments were ultimately unsuccessful before the Tax Court of Canada (“TCC”).
Morton had income of between approximately $100,000 and $200,000 in each of the 1998 through 2001 taxation years (“Taxation Years”), filed income tax returns and paid tax as required. In 2008, after the limitation period for being reassessed had expired, Morton filed T1 adjustment requests (“T1 ADJs”) with the CRA for each of the Taxation Years. Morton’s T1 ADJs included very substantial, but completely fictitious expenses resulting in significant losses. If accepted by the CRA, the T1 ADJs would have generated refunds of over $200,000. The CRA rejected the T1 ADJs and assessed penalties of more than $75,000. Morton appealed to the TCC.
Morton admitted that the expenses and losses claimed in his T1 ADJs were fictitious. The evidence strongly suggested that he was either counseled by or learned about filing positions advocated by Fiscal Arbitrators, an organization whose untenable tax advice has been previously strongly criticized by the TCC. The TCC held that Morton knowingly prepared and filed fictitious T1 ADJs. Morton however relied on a number of unique legal arguments to challenge the penalty assessments, summarized as follows.
- “The penalty reassessment was statute-barred since no misrepresentation occurred in filing a return, but merely in supplying information under the ITA. In the absence of fraud, merely supplying information to the CRA is not enough to reopen statute-barred years”.
This argument was advanced despite the fact that Morton deliberately asked the CRA to reopen the Taxation Years and reassess him in accordance with fictitious tax filings. The TCC rejected the argument, holding that the Taxation Years were not statute-barred because Morton’s tax filings were fraudulent. The CRA arguably accepted Morton’s request to reopen the statute-barred Taxation Years and behaved appropriately – by denying the deductions and assessing penalties.
- “No refunds or reassessments conferring benefit on the taxpayer were generated as a result of the T1 ADJ.”
The TCC held that this was nonsensical. Upon receiving a T1 ADJ, the CRA may reassess tax, interest or penalties. It would be highly artificial to require the CRA to issue a reassessment or refund in accordance with the T1 ADJ, then immediately rescind the reassessment or refund and assess penalties. According to the TCC, it makes more sense for the CRA to simply rely on the T1 ADJ as filed, rather than go through a contrived process of issuing then revoking reassessments of the T1 ADJ to establish that penalties should apply.
- “The T1 ADJs were not ‘returns, forms or certificates’ within the meaning of ss. 163(2)”.
The TCC also gave this argument short shrift. Subsection 163(2) of the ITA refers to false statements or omissions in a return, form, certificate, statement or answer filed or made in respect of a taxation year. According to the TCC, T1 ADJs are a simple and efficient way to amend past tax returns without needing to file fully amended returns. The T1 ADJ and ordinary T1 are very similar in form and content and the taxpayer’s certification on the T1 ADJ states that the “information on this form and any documents attached is, to the best of my knowledge, correct and complete.” According to the TCC, suggesting that a T1 ADJ is not a “form” containing “statements” was not supportable on the plain text, context or purpose of the relevant provisions. Morton’s argument also ignored the nature of the self-assessment/voluntary compliance system for tax reporting, which requires accuracy and which sanctions negligent and fraudulent behaviour. A T1 ADJ is a return for the purposes of ss. 163(2) penalties under the ITA. In my view, were this not the case taxpayers could file fraudulent T1 ADJs with impunity, which cannot be a correct interpretation of the law.
- “CRA administrative guidance suggests that the CRA will generally not accept a T1 ADJ request when the adjustment of a statute-barred year would result in increased taxes, interest or penalties of other individuals that are statute-barred from reassessment.”
The TCC again gave little credit to this argument, concluding that no other taxpayers were involved and in any case the wording of the CRA’s administrative position was equivocal because it used the word “generally”. In the TCC’s view, even if any of the administrative guidance were binding, which it is not, the situations considered in that guidance were not analogous to Morton’s situation.
This case was more interesting for the TCC’s views on the nature of T1 ADJs and the interaction between ss. 152(4.2) and 163(2) of the ITA than as a penalty case, since the taxpayer’s misconduct was clear and purposefully claiming massive fictitious expenses should result in gross negligence penalty assessments. Morton’s arguments were legalistic and technical. Even if the legal arguments were persuasive, Morton’s conduct was so egregious that the TCC was unlikely to hold its nose long enough to rule in favour of someone who blatantly abused the tax system. This case should remind taxpayers and their advisors that even though the TCC is not a court of equity, a common sense approach should inform persuasive submissions. Blatant bad behaviour is not likely to predispose a judge to a favourable finding on factual or legal merits of an appeal. Further, although the TCC did not engage in express consequentialist reasoning, had the appeal been allowed this could have been regarded as clearing the way for individuals to file bogus T1 ADJs for statute-barred years, without risk of civil penalties (criminal sanctions would be another story, of course).