A New Approach to Subsection 163(2) Penalties
The subsection 163(2) penalty applies if the taxpayer (1) knowingly made
a false statement, or (2) made a false statement in circumstances
amounting to gross negligence. Although cases of this type are typically
decided on the basis of whether test 2 applies, two recent cases have
been decided using test 1: Wynter v. Canada (2017 FCA 195, aff'g. 2016 TCC 103) and Bolduc v. The Queen (2017 TCC 203). Bolduc was decided after, and specifically referred to, Wynter. In both cases, the Crown tried to justify the penalty by using a wilful blindness argument; this argument was accepted in Wynter but rejected in Bolduc.
In both cases, the taxpayer retained a Fiscal Arbitrators-like tax
return preparer who claimed fictitious business losses and responded to
CRA queries with "natural person" tax-protester language. The CRA
reassessed to deny the business losses and applied the penalties under
subsection 163(2). In Wynter, the taxpayer noticed the business
losses but did not make sufficient inquiries to determine whether they
were false or true, and simply filed the return. In Bolduc, by
contrast, the taxpayer attempted to understand his income tax return. He
asked why he was reporting a business loss, and he was told by his tax
preparer that the loss was the mechanism to qualify for a "loss
carryback" program, which was described to him as similar to an
interest-free loan. These answers made sense to the taxpayer, and he
filed the return.
Both cases were decided on the basis of wilful blindness, a criminal-law
concept not referred to in subsection 163(2). The leading case on
wilful blindness and subsection 163(2) is Torres v. The Queen (2013 TCC 380; aff'd. as Strachan v. Canada, 2015 FCA 60).
In essence, wilful blindness is present when a taxpayer is aware of the
need to make inquiries in order to prepare a correct return but chooses
not to do so. The taxpayer in Wynter was held to be wilfully blind and hence subject to a subsection 163(2) penalty, but the taxpayer in Bolduc
was not (on the basis of his inquiries and other factors). The
connection that the FCA made between wilful blindness and subsection
163(2) was that a taxpayer who is wilfully blind is, in effect,
knowingly making a false statement—which is test 1.
The FCA also clearly stated that wilful blindness and gross negligence
are two separate concepts. Gross negligence is determined by an
objective assessment of the taxpayer's comportment, but wilful blindness
is determined by reference to a taxpayer's subjective state of mind. A
wilfully blind taxpayer is also grossly negligent, but a grossly
negligent taxpayer is not necessarily wilfully blind. However, the
decision in Bolduc demonstrates that if the taxpayer is not
wilfully blind, the Crown will have to point to some other evidence or
actions of the taxpayer in order to establish gross negligence. In Bolduc, the Crown was unable to do so; thus, the subsection 163(2) penalty was not applied.
Daniel J. Morrison
KPMG Law LLP, Calgary