New Defence to Penalties: The Judge-made Due Diligence Defence

New Rules Now In Effect

The Canada Revenue Agency (“CRA”) has the job of administering the nation’s taxation system. One of the ways that Parliament enables CRA to do that job is by legislating various tax-related penalties that are meant to deter taxpayers from being non-compliant.

The Canada Income Tax Act includes penalties for gross negligence, repeated omissions, and late filing, to name a few. Some of these penalties, the gross negligence penalty chief among them, have a built-in defence. If you can show that you acted with reasonable care, you may be able to avoid those penalties.

Other penalties, however, including most late-filing penalties, are what courts refer to as “absolute liability” penalties. According to the letter of the law, there is no defence to these penalties – as long as the act or omission occurred, you have to pay the penalty.

Over the years, the Tax Court of Canada has come to the rescue of a number of taxpayers facing absolute liability penalties. Although the Income Tax Act provides no defence, the Tax Court judges have created one: the judge-made due diligence defence.

In the recent case Douglas v. The Queen, 2012 TCC 73, the taxpayer had filed his tax return late. He did so because he knew there was no balance owing, and as the court said, everyone in Canada knows that if you don’t owe tax, you don’t have to file on time.

However, what Mr. Douglas didn’t realise was that although he faced no penalties on tax owing (because he didn’t owe tax), he was exposed to another penalty: the late-filing penalty for T1135 Foreign Income Verification Statements, which have to be filed by taxpayers who have foreign assets with a cost base in excess of $100,000. Although the T1135 is usually filed at the same time as your Income Tax Return, and is due on the same date, it is actually a separate Information Return, and the Income Tax Act states that if you file an Information Return late, you are liable for a penalty of $25 per day, up to a maximum of $2,500.

Mr. Douglas filed his T1135 more than 100 days late, and CRA assessed Mr. Douglas with the maximum $2,500 penalty. Mr. Douglas appealed, and the Tax Court reversed the penalty, on the grounds that Mr. Douglas had acted with due diligence. He had delayed filing his tax return because he knew he had no balance owing. The T1135 instructions said to file the form with his tax return, and Mr. Douglas followed these instructions. As a result, the Tax Court found that Mr. Douglas had acted reasonably, and his actions did not warrant a penalty.

In another case, Khalil v. The Queen, [2003] 1 CTC 2263, the taxpayer, a new immigrant to Canada, reported all of her cash income on her income tax returns. However, she did not report income from T4 slips on her return, as she reasoned that her employer had already remitted the tax withheld and reported the income to CRA. CRA assessed an omission penalty for failing to report the T4 income twice within a 4 year period. The court read in a due diligence defence to the penalty, and found that she had not “failed to report” the T4 amounts, due to the diligent approach she took to completing her tax returns within the scope of her limited knowledge of the Canadian tax system.

If CRA has assessed you with penalties, give us a call to set up an initial consultation. We can advise you if there are options available to fight the penalties. CRA may not be on your side, but we are, and the Tax Court may be too!

About the Author

---

David J. Rotfleisch

David J. Rotfleisch, a leading Canadian tax lawyer, is not only a certified specialist in taxation but also a chartered professional accountant. Most recently, David is a pioneer in Canadian crypto taxation.

As of April 2020, he was one of 12 Ontario Certified Specialists In Taxation™.

Learn more about David J. Rotfleisch