Learn about the gross negligence tax penalty

Clients who attempt to cut their tax bills by claiming losses that aren’t really theirs risk ultimately having to pay the tax owing, along with arrears interest.

Not only that, they may also face a “gross negligence” penalty, which applies if a taxpayer knew or, “under circumstances amounting to gross negligence,” ought to have known that a return was incorrect. The penalty is generally equal to 50% of the tax avoided.

The case

A recent tax case (Chartrand v The Queen, 2015 TCC 298) should serve as a warning to clients who approach you about a tax scheme that seems too good to be true. The case’s judge explained that “unscrupulous tax preparers,” Fiscal Arbitrators, “lured” taxpayer Patrick Chartrand into using their services to prepare his tax return with the promise of “huge tax refunds.” These refunds would be the result of fictitious business losses the taxpayer would claim, despite the fact that he had never owned nor operated any kind of business.

Chartrand found himself in Tax Court because CRA not only denied his nearly $547,000 of fictional business expenses, but also hit him with a federal gross negligence penalty of nearly $55,000, in addition to provincial penalties, plus interest.

The issue before the court was whether Chartrand “either knowingly, or in circumstances amounting to gross negligence, made or acquiesced in the making of false statements in his return.” If he had, he would be subject to harsh gross negligence penalties.

Background

Chartrand, a skilled tradesman, worked as a carpenter for 28 years. Before 2009, he had H&R Block prepare his tax returns, and paid about $200 annually for this service. In those years, he reported only T4 employment income, and his typical refund amounted to a couple of thousand dollars.

A colleague introduced him to Fiscal Arbitrators, and that colleague arranged for him to attend an informational seminar in late 2009 or early 2010. At that seminar, Fiscal Arbitrators showed him a way to get more money back from the government. Fiscal Arbitrators charged an initial fee of $500 to prepare his return and then took 20% of any tax refund received.

In Tax Court, the taxpayer testified that “the fact that he had to pay Fiscal Arbitrators much more than he had paid H&R Block in the past did not ring any alarm bells.”

Well, it should have.

Fiscal Arbitrators prepared his tax return for 2009, reporting his employment income of $113,126 from his T4 and some miscellaneous employment income of about $1,027 from a T4A slip. He had no other income.

Yet, on his 2009 tax return, Chartrand also claimed gross business income of $134,702 and business expenses in the amount of $546,817, resulting in a net business loss of $412,115. He used $109,362 of the claimed business losses against his 2009 taxation year, which would have resulted in a refund of $35,899—exactly equal to all of the taxes withheld at source by his employer in 2009. Chartrand then filed a loss-carryback request, asking that the unused balance of his 2009 business loss be carried back and applied to his 2006, 2007 and 2008 taxation years. Doing so would result in the refund of almost all taxes paid for those years.

Taxpayer’s position

While the taxpayer admitted he was expecting a refund of close to $36,000, “this still did not raise any red flags in his mind.” In court, he acknowledged that “it would not be normal for him not to pay any taxes at all over a four-year period, but he felt that if he could get such a large return, then he was up for it.” He also admitted that “if every citizen in Canada tried to do this, then the country would be bankrupt.”

Chartrand argued he did not understand tax returns and that he simply looked over the materials and did whatever Fiscal Arbitrators told him to do, including signing his returns without asking for any explanation. He said that if he was guilty of anything, it was “ignorance for not reading his return before signing it and sending it to the CRA.”

CRA’s position

CRA argued that Chartrand made a false statement in his return, either knowingly or in circumstances amounting to gross negligence. At the very least, CRA said the taxpayer “was willfully blind regarding the fraudulent scheme engaged in by his tax preparer.”

The decision

The judge agreed with CRA, adding, “It is difficult to feel any sympathy for the [taxpayer]; he was blinded by greed. Had he even bothered to consider the information that he, by his signature, certified to be correct and complete, he would have quite easily discovered that his return contained information that was patently false. He would have realized, with just a little bit of thought, that this kind of stratagem was a fraud perpetrated on the CRA and, by extension, on every other Canadian taxpayer.”

The judge upheld the gross negligence penalties.

Jamie Golombek

Tax & Estate

Managing Director, Tax and Estate Planning, CIBC Private Wealth Team Jamie Golombek is Managing Director, Tax and Estate Planning with CIBC in Toronto. As a member of the CIBC Private Wealth team, Jamie works closely with advisors from across CIBC to support their clients and deliver integrated financial planning and strong advisory solutions. He joined the firm in 2008 after 12 years with a global investment company, where he was involved in both internal and external consulting on all areas of taxation and estate planning. Jamie has also worked for Deloitte as a tax specialist in the Toronto office, where he specialized in both personal and corporate tax planning. Jamie is quoted frequently in the national media as an expert on taxation. He writes a weekly column called “Tax Expert,” in the National Post, has appeared as a guest on BNN, CTV News, and The National, and for several years was a regular personal finance guest on The Marilyn Denis Show. He received his B.Com. from McGill University, earned his CPA designation in Ontario and qualified as a US CPA in Illinois. He has also obtained his Certified Financial Planning (CFP) and Chartered Life Underwriting (CLU) designations. In 2023, Jamie was named a CPA Ontario Fellow. The FCPA is the highest distinction that can be bestowed upon a CPA who brings distinction to themselves and to their profession through leadership and achievement in their professional, community or personal lives. Jamie is a past chair of the Investment Funds Institute of Canada’s Tax Working Group. He is also a member of CPA Ontario, the Illinois CPA Society, the Estate Planning Council of Toronto, the Canadian Tax Foundation and the Society of Trust and Estate Practitioners. For nearly two decades, Jamie taught an MBA course in Personal Finance at the Schulich School of Business at York University in Toronto.