In a recent Tax Court of Canada decision, a taxpayer appealed a gross negligence penalty imposed by the Canada Revenue Agency after a fraudulent tax return was filed without her knowledge.

Tax Firm Files Amended Tax Return Without Taxpayer’s Knowledge

On April 30, 2011, the taxpayer filed her income tax return for the 2010 taxation year. In the return, she reported a total income of $78,798. 

On May 12, 2011, the Minister of National Revenue (the “Minister”) initially assessed the taxpayer’s 2010 taxation year as filed.

However, a few months later, the taxpayer and her husband learned of a tax consulting firm, which they believed offered tax services. The couple thought that the firm looked at people’s income tax returns and evaluated whether they were entitled to additional money from the Canada Revenue Agency. The couple eventually agreed to use the firm’s services by signing up for a “membership kit”.

Unbeknownst to the couple at the time, the firm was actually illegitimate and defrauded hundreds of people. In fact, the firm operated a tax scam by filing amended income tax returns that attempted to generate illegal tax refunds by claiming fraudulent expenses. Eventually, criminal charges would be laid against the firm’s owners.

In the meantime, on March 26, 2012, the firm filed an amended income tax return on behalf of the taxpayer for her 2010 taxation year. The total income reported for the taxpayer remained the same as reported in the income tax return originally filed, but net business losses of $666,447 were claimed in respect of a “consulting business”. Net capital losses of $333,024 were also claimed as a result of the disposition of bonds, debentures, promissory notes and other similar properties. Finally, requests to carry back non-capital losses of $32,566, $39,021 and $50,214 to the taxpayer’s 2007, 2008 and 2009 taxation years were also included in the return.

The taxpayer did not know that the firm had filed the amended income tax return nor did she know anything about its contents. 

Subsequently, on June 12, 2014, the Minister reassessed the taxpayer’s 2010 taxation year to disallow the business losses, the net capital losses and the carry-back losses claimed in the 2010 amended income tax return. Pursuant to subsection 163(2) of the Income Tax Act, the Minister also imposed a gross negligence penalty of $139,032 on the taxpayer.

The taxpayer appealed.

On appeal to the Tax Court of Canada, the Minister took the position that the taxpayer had made false statements in the 2010 amended income tax return. It submitted that shehad acted in a wilfully blind manner. It claimed that there had been sufficient warning signs for the taxpayer to make further inquiries prior to the filing of her 2010 amended income tax return, which she had not done.

In response, the taxpayer acknowledged that her 2010 amended income tax return contained false statements. However, she submitted that the gross negligence penalty should be vacated because she had not “made” the false statements as she had not authorized the firm to file the return. She submitted that there was no basis for finding that she had “participated in, assented to or acquiesced in the making of” the false statements since she did not have knowledge of the filing of the return and did not provide any information to help the firm make the false statements.

Court Allows Taxpayer’s Appeal

After reviewing the evidence and applicable legal principles, the court allowed the taxpayer’s appeal, concluding:

“The Court concludes, on a balance of probabilities, that [the taxpayer] did not knowingly, or under circumstances amounting to gross negligence, make or participate in, assent to or acquiesce in the making of a false statement in her 2010 Amended Income Tax Return.

Therefore, the Minister did not rightfully impose on [the taxpayer] a gross negligence penalty of $139,032 in respect of her 2010 Amended Income Tax Return pursuant to subsection 163(2) of the ITA. As such, the gross negligence penalty is vacated.”

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Mark Feigenbaum brings together many years of litigation experience with a deep knowledge of tax law, corporate law, accounting, finance, and other related practice areas. Mark can help you avoid the biggest risks that may arise in tax disputes.

Prior to founding his law firm, Mark worked in the cross-border tax department of an international Big 4 firm, and held accounting management positions across a variety of sectors in both Canada and the United States.

With tax legislation in constant flux on both sides of the border, Mark takes great care to stay current on all relevant developments in law and policy. He carefully considers all solutions available to craft a response that proactively considers the policies and best practices of a given tax authority.

If you are involved in a tax dispute or related litigation, contact Mark Feigenbaum for exceptional representation and guidance. Mark’s many years of interdisciplinary knowledge in law, tax, accounting, and finance and significant cross-border experience make him uniquely positioned to assist you. Mark offers services to clients in the U.S., Canada and around the world. Contact Mark online or call him at (905) 695-1269 or toll-free at (877) 275-4792 to book a consultation.