Our obligation as taxpayers to file an accurate return of income has been described by one Tax Court judge as “a bedrock of the tax system.” When a return that accurately reports the taxpayer’s income and deductions has been assessed, the Minister has a limited period (generally 3 years for individuals) to make a reassessment. However, if the Minister can show that the taxpayer “made any misrepresentation that is attributable to neglect, carelessness or wilful default” in the return, a reassessment may be made at any time after the 3 year period. Suppose a taxpayer fails to report the receipt of an amount because she believed the payor when he said the amount was not taxable. Suppose also that it later turns out that the Minister is correct in treating the amount as income. It is clear from the case law that the failure to report the amount is a misrepresentation, but in what circumstances will it be attributable to neglect or carelessness? This becomes a critical question if the Minister issues the reassessment after the expiry of the 3 year period.
In the Johnson case I discussed in my October 26 post (A Letter from the Côte d’Ivoire), the taxpayer received payments from the promoter of a ponzi scheme. The promoter assured her that the payments were not taxable in her hands and she testified that she believed him. Although the amounts involved were substantial – $600,000+ in 2002 and $702,000 in 2003 – she did not include them in her returns for those years. The Court of Appeal held that the payments were taxable in her hands (2012 FCA 253) and that she was careless in not checking out the promoter’s advice with an experienced tax advisor. The Court’s reasoning here is instructive.
The taxpayer was described by the Tax Court judge as “someone who was quite astute in business matters.” The promoter was introduced to her by a financially savvy business friend who had been successful in investing with him on her own account. Although the taxpayer had not previously met the promoter, she was aware of him through church and other community connections. (Inference: she had reasonable grounds for thinking he was trustworthy.) As noted above, she received substantial payments from the promoter in 2002 which, he assured her, were tax free in her hands because the amounts had been subject to tax in the trust through which her investments had been made. She took the precaution of obtaining a letter from the promoter confirming that tax had been paid on the amounts paid to her. About the time she was filing her 2002 tax return (April 2003), there was the first indication that something might be amiss with the promoter. The bank refused to cash his cheque in payment of the amount due her that month. She believed the promoter when he said that this was temporary delay attributable to a “minor administrative problem” at the bank.
It was in these circumstances that the Minister reassessed the taxpayer in 2007 (after the expiry of the 3 year period) to include the 2002 payments in her income. If the amounts were of an income nature, they were taxable, unless the taxpayer was entitled to the 3 year limitation period on reassessments. The Tax Court said that she was, but the Court of Appeal disagreed. Both courts agreed on the legal test to be applied which, in this case, was whether the taxpayer had been “careless” in not reporting the receipts. They also agreed that the taxpayer would not be found to be careless if she “considered the matter thoughtfully, deliberately and carefully,” and filed “on what (she) believes bona fide to be the proper method.” In an earlier case, the court said that the standard here “must be that of a wise and prudent person.” I don’t disagree with any of these statements as to the law, but it does seem to me that there is an air of unreality in how they were applied in this case.
Most experienced tax professionals of my acquaintance freely admit that the Income Tax Act is not user friendly; to the uninitiated, it is unfathomable. The message from this case seems to be that an independent tax expert should be consulted when preparing a return that relates to anything that is in the least way out of the ordinary. Assurances from friends, business acquaintances or other non-experts are not to be relied on, even when they are generally knowledgeable and trustworthy. As a practicing tax professional I suppose I should be grateful to the court for promoting my business, but I can’t help feeling that the burden already placed on taxpayers trying to comply with the tax rules when preparing their tax returns is such that holding them to the standard imposed in this case to preserve the limitation period is somehow unreasonable. I should note, though, that the Minister did not assess penalties in this case. That’s some comfort, I guess.