Repeated Failure to Report Income Tax Penalty: Canadian Tax Penalties

Introduction – Repeated Failure to Report Income Penalty

Canada’s income tax system is designed around every taxpayer filing an annual return which reports all of the income that taxpayer earned during the year. To help enforce this system, the Canada Revenue Agency has been empowered to impose a variety of different tax penalties when taxpayers fail to live up to their tax reporting obligations. One of the harsher tax penalties applies when a taxpayer repeatedly fails to report all of the income the taxpayer was required to include on his, her, or its returns. This repeated failure to report income penalty has also seen recent legislative action as it was amended in 2016 to be slightly less harsh.

Conditions for Application of Penalty – Repeated Failure to Report Income Penalty

The penalty applies to a taxpayer who:

1. fails to report an amount required to be including in computing the taxpayer’s income for a particular tax year in the taxpayer’s annual income tax return for that year,
2. the taxpayer is not liable for tax gross negligence penalties with respect to that amount, and
3. had failed to report an amount required to be so included in taxpayer’s annual income tax return for any of the preceding three years.

For tax years beginning during or before 2014, the penalty applied no matter how small the unreported amounts were. For tax years beginning after 2014 the penalty was altered so that the penalty only applied when the amounts failed to be reported were at least $500 in income. This means that the penalty can apply when there is little or no unpaid tax.

The penalty only applies when amounts of income aren’t reported in the taxpayer’s return. The penalty does not apply when no tax return is filed. The penalty is not triggered by incorrect claims of deductions or credits by the taxpayer.

The repeated failure to report income penalty is a strict liability penalty. The penalty will apply so long as the requisite failures to report occurred. There is no bad intention (mens rea) for applying the penalty, in other words the taxpayer need not have intentionally misreported income, acted in bad faith, or acted carelessly for the penalty to apply. The CRA does however has the burden of proof to make a prima facie case that the taxpayer earned the unreported income amounts.

The gross negligence penalty referenced in the repeated failure to report income tax penalty criteria above is a different penalty with different criteria for application which do include a bad intention requirement. The gross negligence penalty applies when a taxpayer knowingly or under circumstances amounting to gross negligence makes a false statement or omission in a tax return.

It is however possible for taxpayers to defeat application of the tax penalty if they can successfully make a due diligence defense. A due diligence defence requires the taxpayer to show all reasonable steps were taken to avoid the failure to report or that the taxpayer reasonably believed in a set of facts that would render the taxpayer’s tax filing position correct.

Amount of Penalty – Repeated Failure to Report Income Penalty

Due to an amendment to the federal Income Tax Act in 2016, the amount of the penalty is calculated differently depending on whether tax year the penalty is being applied to began after 2014 or not.

For tax years beginning during or before 2014 the penalty is equal to 10% of the unreported income amount from the particular year to which the penalty applies.

For tax years beginning after 2014 the penalty is the lesser of

1. 10% of the unreported income amount from the particular year to which the penalty applies, and
2. the amount determined by the formula: 0.5 × (A – B).

The variable “A” is normally the additional income tax that the taxpayer needs to pay once the unreported amount is included in the taxpayer’s income. The variable “B” is the sum of the tax withheld or deducted at source (e.g. by an employer from an employee’s salary) with respect to the relevant amount.

In addition, typically a parallel provincial income tax penalty will be charged whenever the federal income tax penalty applies. As of October 1st, 2020, Ontario charges a penalty identical to the pre-2016 amendment version of the federal penalty.

Pro Tax Tips – Repeated Failure to Report Income Tax Penalty

If a CRA auditor has applied or proposed applying this tax penalty to you, it is essential to consult with an expert Toronto tax lawyer to determine the best way to address the tax penalty. It may be possible to defeat the application of the penalty through either disputing CRA’s underlying analysis of your situation, whether the penalty applies, or through a due diligence defence.

The repeated failure to report income tax penalty, particularly the pre-amendment version, is a harsh penalty which can sometimes apply in an unfair way. In some circumstances, an experienced Toronto tax lawyer may be able to assist you in getting a tax penalty cancelled through applying for discretionary relief from CRA.

If you know that the tax penalty may apply to you but CRA has not yet discovered this fact, it may be possible to eliminate this tax penalty through a voluntary disclosure application where you proactively disclose your non-compliance to the CRA. If you may be in this situation, it is essential to get the assistance of a top Canadian tax lawyer as soon as possible.