Clients who fail to report income will not only be liable for the tax owing on the undisclosed income, plus arrears interest. They could also be hit with a “gross negligence” penalty.

This penalty can apply if your clients knew or, “under circumstances amounting to gross negligence,” ought to have known that income should have been reported on their returns. The penalty is generally equal to 50% of the understatement of tax payable related to the omitted income.

A tax case (Phénix v The Queen, 2018 TCC 204) decided last fall involved a taxpayer who omitted reporting the dividend income from his private company on his 2013 tax return. The taxpayer admitted he forgot to include the dividend and that the tax on that dividend was owing, so the only issue before the Tax Court was whether to uphold the Canada Revenue Agency’s gross negligence penalty.

To be charged a gross negligence penalty, the CRA must demonstrate on a balance of probabilities that the taxpayer’s behaviour “includes a high degree of negligence corresponding to a deliberate action or indifference in terms of compliance with the [Income Tax] Act.”

As the judge explained, an “ordinary negligence error is insufficient to find the taxpayer guilty of gross negligence. The finding of gross negligence must be decided based on all evidence of the particular circumstances of [the case].”

The taxpayer founded his business in 1983. His company has “important” clients throughout the world, a staff of 20 employees and an approximately $10-million turnover, the court heard. The taxpayer travels internationally five or six times a year, for periods of two to four weeks.

The taxpayer hires professionals for his business and personal tax accounting. His internal auditor worked for the company for more than 10 years, while his external auditor began working for the company in 2005. The accountant who prepared his tax returns was familiar with the company.

In most years, the taxpayer received a mix of salary and dividends from his company, with the mix determined by the internal and external auditors. The 2013 tax year was unique as it was the first time the company had hired the external auditor to prepare its T5 forms, which report dividends paid. The taxpayer did not know about this change.

In prior years, the company’s internal auditor had prepared the T5 forms along with the T4s to report the salary remuneration, and distributed both slips together, by hand.

The external auditor changed firms in 2012 but continued to work with the company. The taxpayer was unaware that the auditor had changed firms.

The external auditor sent the 2013 T5 form by mail to the taxpayer’s personal address.

Except for the omitted dividends in 2013, the evidence indicates no other error or omission in the taxpayer’s tax returns, either before or since.

Based on all these facts and circumstances, the judge was of the opinion that the omitted dividends were the result of a reasonable error or ordinary negligence—not gross negligence.

The taxpayer had continued to follow the same process as usual and to use the same professionals, and he had the same company as his sole source of income in each prior tax year. His external accountant, who prepared his tax return, had also not noticed that he may have been missing a T5 form in 2013.

The judge said that even if the taxpayer had fully read and reviewed his 2013 tax return, it is unlikely that he “would have made note of this omission.”

As a result, the judge concluded that the omission in the return was not made knowingly or under circumstances equivalent to gross negligence, and ordered the gross negligence penalty to be cancelled.

Jamie Golombek , CA, CPA, CFP, CLU, TEP is the Managing Director, Tax & Estate Planning with CIBC Financial Planning and Advice in Toronto.