Under subsection 163(1) of the Income Tax Act, a taxpayer who fails to report income in two tax returns out of four tax years is liable to a 10% penalty based on the unreported amount of tax. A matching provincial penalty applies. (See “Lower Penalties Cost More” on this website.) The penalty applies even if taxes were withheld at source and reported to CRA by the payer on a T4 or other prescribed form.
Mr. Galachiuk failed to report $683 in investment income in his 2008 return and failed to report $436,890 of pension income in his 2009 return. CRA assessed the failure to report penalty for 2009. Obviously, the penalty was very large. (J. Graham estimated it was 220% of the unreported tax net of withholdings.)
Justice Graham noted that the Court has been divided on whether a taxpayer can defend himself against the penalty by showing due diligence in either the first or second tax year of under reporting. After discussing the cases, he sided with those judges who say a taxpayer may defend himself by showing due diligence in either tax year. (This became the first General Procedure decision of the Tax Court on this issue of the s. 163(1) due diligence defence.)
“[8] With respect, I prefer the reasoning of Justice Webb over that of Justice Angers. As I stated above, subsection 163(1) is a very harsh provision. Its application all too frequently results in a penalty that bears little or no relation to the gravity of the wrong committed by the taxpayer[4]. Given the harsh and potentially disproportionate results of this penalty, if Parliament wanted to limit the circumstances in which a due diligence defence would be available, I believe that it would have expressly stated so in the subsection. Absent such an express limitation, it is my view that a due diligence defence is available to explain the omission in either year.
“[9] It appears to me that the idea that the due diligence defence is only available in respect of the second failure to report is based, in part, on the belief that the first failure to report is intended to serve as a warning to the taxpayer that he or she must be particularly careful to avoid a second failure if he or she wants to avoid a penalty. I would be more open to this interpretation if there were a condition in subsection 163(1) that stated that the penalty could only be imposed if the taxpayer had first been reassessed in respect of his or her first failure to report. A precondition such as this can be found in respect of the repeat failure to file penalties in subsection 162(2). That subsection applies a larger failure to file penalty to a tax year where a taxpayer has previously failed to file a return for a previous tax year on time. However, the larger subsection 162(2) penalty is only applicable if the normal subsection 162(1) failure to file penalty has already been assessed for the previous failure to file at the time the second failure to file occurs.”
Justice Graham found the taxpayer duly diligent for the 2008 tax year (where the omission was only 0.1% of his total income.) Because he expected the Crown to appeal, J. Graham also looked at the 2009 tax year. He did not accept that the taxpayer was diligent enough for the 2009 year omission.