The tax scheme made no sense but the participants didn't question it too much. Their friends or family had introduced them to Fiscal Arbitrators (or similar "tax preparers") and they naively took part in the scheme. Tax laws are complex, as their counsel argued. So they assumed that the "experts" knew something they just couldn't understand. All that the taxpayers really seem to have relied on was the fact that others got refunds, making the scheme seem credible. (See e.g., para. 16.) And, of course, they foresaw "no downside". (Paras. 26 and 69(g).)
But the scheme only worked because CRA's normal screening process failed to catch the fraud. Once CRA discovered the mass of these fraudulent loss claims, the audits began and CRA imposed gross negligence penalties.
The way gross negligence penalties are calculated, the amount depends on the total loss claimed. The resulting penalty is financially ruinous to any of those who took part in the scheme because the plan involved claiming losses large enough to wipe out all taxes payable by these middle-income employees over a four-year period.
Of course taxpayers are shocked by the size of the reassessments, which typically demand penalties and interest amounting to more than a year's worth of their pre-tax income. But in striving to defend themselves, the taxpayers face a major hurdle in proving they were not "grossly negligent": None of them ever "called the CRA to inquire of the correctness of the arrangement", despite their suspicions. (Para. 47)
The CRA has not been merciful. Nor have the Courts. See
Bhatti v. The Queen, (2013 TCC C Miller), Brochu v. The Queen, (2011 TCC Favreau), Brisson v. The Queen, (2013 TCC V. Miller), and Chénard v. The Queen, (2012 TCC Bedard). (See also, Morton v. The Queen, (2014 TCC Bocock))
The TCC has felt the taxpayers deserved these penalties because they were "wilfully blind". "[W]ilful blindness arises where a person who has become aware of the need for some inquiry declines to make the inquiry because he does not wish to know the truth." (Para. 63)
For "warning signs" that should tell a taxpayer to inquire further, Justice Miller gave this list:
a) Magnitude of the advantage.
b) Blatantness of false statement – readily detectable.
c) Tax preparer does not acknowledge preparing return.
d) Tax preparer makes unusual requests.
e) Tax preparer previously unknown to taxpayer.
f) Explanation by tax preparer regarding false statement is incomprehensible.
g) Others do not do it or the taxpayer is warned against it or the taxpayer is fearful of telling others. (Para. 69)
See Torres v. The Queen, (2013 TCC C. Miller)