What the Supreme Court of Canada Has to Say About The Income Tax Act and Penalties

Published by Greg DelBigio, Q.C.

It is not often that tax cases wind their way to the Supreme Court of Canada  so both that Court’s judgments on specific points of tax law, as well as it’s more general observations about tax law are of interest. The recent decision of Guindon v. Canada, 2015 SCC 41 was much awaited for these reasons and also because court watchers and practitioners were anxious to see whether the Appellant’s success (and perhaps surprising success) at the trial level, which was overturned on appeal, would be restored. It was not.

At issue was whether the penalties imposed by s.163.2 of the Income Tax Act are so severe that the provision is criminal, rather than administrative in its nature. If criminal, the protections guaranteed by the Charter of Rights to those charged with a criminal offence would apply to those subject to these penalties.

The Appellant was a practicing lawyer but she did not practice tax law. She was retained to provide, and did provide an opinion on the tax consequences of a particular charitable donation program that was being promoted. For her efforts she received a fee of $1000.00. She was aware that her opinion would form part of the promotional materials and the opinion was based upon a precedent provided to her by the promoters of the scheme.  Unfortunately for the Appellant, the opinion referred to documents that were said to have been reviewed yet she had not reviewed the documents. Also unfortunately for the Appellant, she seemed to have had some awareness of the limitations of her expertise because she suggested that her opinion be reviewed by someone with expertise in tax law yet this review was never conducted.

The promotion was a success in the very limited sense that donors came forward and made donations to the charity in question and tax receipts were issued. The Appellant was one of the two persons to sign the receipts. Receipts in the amount of $3,972,775 were issued.

It is here that the donation program that was being promoted began to unravel. As characterized by the majority in the Supreme Court judgment, “[t]he scheme was a sham”, the tax credits based upon the donations were disallowed and the Appellant was assessed penalties in the amount of $546,747 pursuant to s.163.2 of the Income Tax Act. Section 163.2 creates both a planner penalty and a preparer penalty. The preparer penalty under which the Appellant was assessed states:

(4) Every person who makes, or participates in, assents to or acquiesces in the making of, a statement to, or by or on behalf of, another person…that the person knows, or would reasonably be expected to know but for circumstances amounting to culpable conduct, is a false statement that could be used by or on behalf of the other person for a purpose of this Act is liable to a penalty in respect of the false statement.

On appeal to the Tax Court, the Appellant argued, and the Tax Court agreed that the penalties created by this provision were criminal in their nature, that the legal effect of the assessment was that she was charged with an offence and therefore, the protections provided by s.11 of the Charter were engaged.

Section 11 begins with the words “Any person charged with an offence has the right” and the guaranteed protections include being informed of the offence charged, being tried within a reasonable time, the right not to be compelled to be a witness in the proceedings and the right to be presumed innocent until proven guilty. On this basis, the Appellant further argued that the proceedings should not be heard in the Tax Court and the assessment should be vacated. Again, in a manner that was unfortunate, no notice of constitutional question, as required by s.19.2 of the Tax Court of Canada Act, was filed and no notice of the constitutional argument was given to the attorneys general of the provinces.

There is no doubt that the penalties that can be imposed by s.163.2 can be significant and, in some instances, crushing. The Appellant’s argument therefore had, at least for some, a certain intuitive appeal. Indeed, the Appellant’s argument had sufficient appeal that she was successful in the Tax Court. The success was, however, short lived and the result was overturned on appeal and the Supreme Court of Canada confirmed that though potentially severe, the tax penalties in question are administrative and not criminal in their nature.

There are several points to be taken from this judgment. The procedural issue was whether the Supreme Court should entertain the constitutional question given that the Appellant has not filed the notice of the constitutional argument as required. Within the Court it was agreed that the Court had a discretion to consider the constitutional question.  The question which divided the court was whether the discretion should be exercised.

The majority held that because the appeal raised issues important to the administration of the Income Tax Act and the public interest, and because no prejudice would arise from the constitutional question being considered, the constitutional question should be adjudicated upon.

Three judges disagreed on the grounds that: notice provides an opportunity for Attorneys General to intervene; notice ensures that a court will have the fullest possible evidentiary record upon which to decide a constitutional question; the wording of the notice provision within the Income Tax Act (s.19.2) is mandatory; given the mandatory language, the Tax Court was not as a matter of law permitted to consider the constitutional question; the SCC can consider new issues but it is a discretion that should be “sparingly” used; the discretion should not be exercised in the present case because “it undermines public confidence because it extinguishes the legislative assurances that this Court will have the benefit of a complete and tested record when scrutinizing the constitutionality of legislation.”

Because of the disagreement within the Court on the procedural question, the substantive or constitutional question was only considered by four judges. In upholding the judgment of the Federal Court of Appeal that the provision is administrative rather than criminal in its nature and that the Appellant was not a person who was charged with an offence, the majority held:

A proceeding is criminal by its very nature when it is aimed at promoting public order and welfare within a public sphere of activity. Proceedings of an administrative nature, on the other hand, are primarily intended to maintain compliance or to regulate conduct within a limited sphere of activity…

A “true penal consequence” is imprisonment or a fine which by its magnitude would appear to be imposed for the purpose of redressing the wrong done to society at large rather than to the maintenance of internal discipline within [a] limited sphere of activity.

When examined in its “full legislative context”, the penalty provision in question is part of a self -reporting scheme “which depends upon the honesty and integrity of the taxpayers for its success”. Further: “We can conclude that the purpose of this proceeding is to promote honesty and deter gross negligence, or worse, on the part of preparers, qualities that are essential to the self-reporting system of income tax assessment.”

In order to ensure that the objectives of an administrative scheme are achieved or, at least not thwarted, significant and even “very large” penalties may be utilized and the majority concluded that the penalties in question were “directly tied to the objective of deterring non-compliance with the ITA.”

It is worth noting that in its analysis, the majority considered the conduct that is captured by s.163.2.  On the appeal, the Minister argued that the conduct “was not intended to be different from the gross negligence standard in s.163(2)” which governs penalties for false statement and omissions. The court held that conduct must be beyond carelessness or simple negligence and must, instead, reflect at least an indifference with respect to compliance or intentional non-compliance. “[T]he standard must be at least as high as gross negligence [and the] third party penalties are meant to capture serious conduct, not ordinary negligence or simple mistakes on the part of the tax preparer or planner.”

To condense this for summer reading, here is what may be taken away from this case. First, if constitutional litigation is to be conducted, it must be properly conducted and failure to comply with notice provisions will likely stop litigation in its tracks regardless of merit.

Secondly, many judicial pronouncements refer to the way in which the integrity and honesty of the taxpayer is integral to the proper functioning of our self-reporting system of income tax. The decision in Guindon illustrates that the integrity and honesty of advisors, planners and tax preparers is equally important to the integrity of the self- reporting system.

Third, the objectives of the Income Tax Act are such that, at least in general terms, very significant penalties will not be prohibited by constitutional principles.

Finally, Guindon serves notice upon tax professionals who are considering a retainer which would require the preparation of an opinion, or assistance with planning or preparation on tax matters. The judgments from the courts do not reveal why the Appellant might have become involved in the manner she did, but the case does make perfectly clear that significant penalties can be assessed upon those who exercise insufficient care or skill in the professional services they provide. Therefore, before any retainer is accepted or undertaken, a person should ask him or herself whether he or she possesses the requisite skill to properly execute the terms of the retainer. Not every case is worth taking and it is easy to imagine that the Appellant in Guindon might now believe that the $1000.00 retainer she received was not worthwhile.