Tax shelters have been around for a long time. The developers and marketers of these arrangements do extremely well. For years, CRA has been trying to shut down the more undesirable tax shelter arrangements. Who doesn’t know someone that has been reassessed by CRA for participation in a leveraged donation plan and been denied the applicable tax credit? Now, CRA is vigorously pursuing those individuals that promoted and marketed the schemes by utilizing the third party civil penalty provisions of the Income Tax Act (the "Act").
The Act empowers the Minister of National Revenue to impose civil penalties on third parties who knowingly, or in circumstances amounting to culpable conduct, make false statements or omissions in respect of another person’s tax matters. The section is designed to apply to tax planners involved in the preparation, promotion or selling of tax shelters, tax shelter-like plans and/or arrangements. The section is also squarely aimed at tax preparers and advisors that either give advice or helped others in the making of a false statement or who are willfully blind to obvious errors when preparing a filing or assisting a taxpayer in filing a tax return.
There are two different types of third party civil penalties. The first is referred to as the “planner penalty”. This penalty potentially applies to any person who makes, furnishes, participates in the making of or causes another person to make or furnish, a “false statement” that could be used by another person for the purposes of the Act.
There are a number of factors that CRA may consider relevant when determining whether planner penalties will be assessed. These considerations include: whether the position was obviously unreasonable or contrary to well established case law; whether the advisor had knowledge of the relevant subject matter and the extent of the advisor’s participation, deliberate or otherwise, in the making of false statements; the degree to which the culpable conduct represents the most aggressive and blatantly abusive behaviour; the extent to which there is a pattern of repeated abuse; and whether the reduction of taxes is significant.
The term “person” used in the language of the planner penalty includes a partnership for the purposes of the third party civil penalties. The planner penalty can also apply regardless of whether the false statement is actually used and regardless of whether the person who could use the information can be identified.
The term “false statement” is defined to include a statement that is misleading due to an omission. CRA takes the position that a person need not have the intention to deceive to make a false statement. However, there is case law that suggests that the person making the false statement must actually know the statement is false.
In addition to a false statement, there must also be actual knowledge, or culpable conduct on the part of the advisor in order for the third party civil penalty to apply. The Act provides a definition for culpable conduct that would appear to exclude an honest error of judgment or a failure to exercise reasonable care. The Act defines culpable conduct as an act or failure to act that:
- is tantamount to intentional conduct;
- shows indifference as to whether the Act is complied with; or
- shows a willful, reckless or wanton disregard of the law.
The second type of civil penalty is referred to as the “preparer penalty”. It is virtually identical to the penalty for false statements in tax planning schemes except that it strictly applies to statements that are “to, or by or on behalf of another person”. This means that there must be an actual taxpayer who can be identified. For this penalty to apply, there must be a “false statement” that is made either knowingly or in circumstances amounting to culpable conduct. The preparer penalty also applies to third parties who assent to or acquiesce in the making of a false statement. Therefore, from CRA’s point of view, tax preparers could be liable for this penalty in circumstances where the preparer does nothing, if he/she knew or would reasonably be expected to have known that their client made a false statement.
The penalty provisions are harsh and the dollar amounts can be incredibly high.
In connection with the imposition of third party civil penalties, CRA is using its audit and investigation powers in order to obtain the necessary evidence to support the penalties. The Act confers on the Minister broad powers of audit and inspection of a taxpayer’s books and records. Under the Act, the Minister can by notice served personally or by registered or certified mail require that any person provide, within such reasonable time as is stipulated in the notice, information or additional information, including a return of income or supplementary return, or any document.
Fortunately, there is a good faith defence built into the statutory framework for the civil penalty provisions. Penalties will not apply where the advisor relied in good faith on information provided by or on behalf of the person for whom he/she acted. The good faith defence also applies where the advisor did not verify, investigate, or correct information.
In the event that you and/or your client are served with a CRA requirement, the optimal course of action is to discuss the specifics of the requirement and the appropriate response with tax counsel. These are “treacherous waters” and a sailor that knows how to navigate through this difficult passage will save the inexperienced from disaster.