In a major decision on the law of imposing so-called “gross negligence” penalties under the Income Tax Act, the Federal Court of Appeal today reiterated that the Minister of National Revenue must lead specific evidence about a taxpayer’s knowledge of (or gross negligence toward) errors in their tax returns in order to impose a penalty under subsection 163(2) of the ITA.
I acted for the Appellant, Veeru Khanna, in the matter.
The case turned around the evidence that the Tax Court had canvassed in order to impose the penalty upon Mrs. Khanna. Madam Justice Monaghan wrote:
[11] The appellant argues that the evidence before the Tax Court did not support a finding she was uncooperative in providing books and records or that she had unreported rental income in 2009. Therefore, she submits, the Tax Court made a palpable and overriding error. Moreover, says the appellant, to the extent that the facts were established with respect to her, they are not sufficient to meet the legal test for the imposition of subsection 163(2) penalties—that she made the misrepresentation knowingly or in circumstances that amount to gross negligence.
[12] I agree.
[13] I have carefully reviewed the transcripts and the documents in the Appeal Book. Nothing suggests the appellant was uncooperative or that she had unreported rental income in 2009. It appears she signed the bank authorization she was asked to sign, as confirmed in the Canada Revenue Agency (CRA) penalty recommendation reports for the appellant and her husband. While the appellant may have agreed her husband would represent her during the audit, the circumstances surrounding that agreement are not on the record. Moreover, Mr. Khanna’s behaviour during the audit does not establish the appellant’s knowledge or gross negligence at the time her 2008 return was prepared and filed, years before the audit, which is the question that subsection 163(2) requires be answered.
The upshot of the case is that the real and meaningful burden on the Minister to establish gross negligence is not exercised merely by pointing out the sloppiness or bad behaviour of other parties. The important aspect for tax practitioners, whether accountants or lawyers, regarding penalties is to always request the Penalty Recommendation Report before advising a client on the likely success of an appeal. CRA often issues penalties, and this is increasingly the case anecdotally, on extremely thin evidence about the taxpayer’s conduct. In this case, at the end of the day there was no credible and non-contradictory evidence that could be used to support the imposition of a penalty.
[21] Ms. Geddes’ penalty recommendation report for Ms. Khanna largely recites facts about Mr. Khanna. In that report, the “Taxpayer’s Knowledge of Tax Matters” and “Taxpayer’s Knowledge of Income” and “Examination of Return Prior to Filing” are all stated to be “Unknown”. No one from CRA met with the appellant and Ms. Geddes testified she never spoke with her.
Gross negligence penalties and the interest upon them often form a significant part of what is owing after an audit. Attention should always be paid to the Minister’s higher burden of proof for such assessments.
EDIT MAY 17, 2022: The decision is indexed as Khanna v. Canada 2022 FCA 84 and the full text is available here.
