Taxpayer penalized following accepted voluntary disclosure

Published by Tyler Berg & David Davies

The decision in Grewal v Canada (National Revenue) involved a taxpayer being penalized in respect of amounts disclosed in a voluntary disclosure, despite the fact that the disclosure was accepted by the Canada Revenue Agency (“CRA”).

This case addressed the application of the CRA’s Voluntary Disclosure Program (“VDP”) and the scope of protection provided by the VDP.  In general, taxpayers who have not previously complied with their tax obligations have the option of disclosing previously-unreported income to the CRA, and paying tax on such income, in order to bring their tax filings into good standing.  In return, the Minister of National Revenue (the “Minister”) (through the CRA) agrees to refrain from penalizing or prosecuting the taxpayer in respect of that disclosure, as well as offering partial interest relief.

In Grewal, the taxpayer initiated an application to the VDP in 2014.  In his application, the taxpayer disclosed unreported income from various sources, and included those amounts on the T1 adjustment forms provided with the disclosure.  The taxpayer also disclosed other amounts received by his holding company, which he classified as non-taxable loans (the “Loans”), and so did not include these amounts on the T1 adjustment forms.

The taxpayer’s VDP application was accepted in 2015, and the taxpayer was reassessed in accordance with his T1 adjustment forms.  In keeping with the terms of the VDP, the taxpayer was not penalized in respect of the unreported amounts that the taxpayer disclosed as income.

The CRA later initiated an audit of the taxpayer’s disclosure.  The Minister eventually proposed to reassess the taxpayer on the basis that the Loans were, instead of being loans to the taxpayer’s holding company, taxable benefits to the taxpayer.  The Minister also proposed to impose penalties on the taxpayer on the basis that the taxpayer’s classification of the Loans as non-taxable amounts in his voluntary disclosure amounted to gross negligence.

The taxpayer initiated a judicial review application in the Federal Court of the Minister’s decision to impose penalties  in respect of the Loans, which the CRA had  classified as taxable benefits.  The taxpayer argued that the Minister was precluded from penalizing the taxpayer in respect of amounts which he disclosed in his accepted VDP application.  He argued that such penalization was contrary to the principles of the VDP and effectively amounted to a reversal of the Minister’s decision to accept his VDP application.  The Minister, in response, argued that she was not precluded from penalizing the taxpayer with respect to Loans, because the Loans were not included on the taxpayer’s T1 adjustment forms as part of his VDP application.

The Federal Court dismissed the taxpayer’s application for judicial review.  The Court held that accepting the taxpayer’s arguments would put him in a “better position” than ordinary taxpayers if amounts classified as non-taxable loans could not later be penalized by the Minister.

This decision raises questions about the scope of protection offered by the VDP.  The Court’s reasons appear to preclude the existence of any legitimate disagreement between taxpayers and the Minister as to the classification of particular amounts as taxable or non-taxable.  This provides future taxpayers who are considering applying to the VDP with a catch-22.  If a taxpayer characterizes certain amounts in a VDP application as non-taxable and the Minister later disagrees, the Minister will be free to penalize the taxpayer for that characterization.  However, if a taxpayer chooses to not disclose these amounts at all, the VDP application might not be considered “complete” (one of the requirements for an acceptable application) and the taxpayer therefore risks being penalized on all disclosed amounts, whether characterized as taxable or not.

In effect, this decision incentivizes taxpayers to classify all amounts in a VDP application as being fully taxable, even if the taxpayer might otherwise take the position that some of those amounts are either eligible for preferential rates (e.g. capital gains) or non-taxable altogether.  The taxpayer’s only recourse will then be to object to their own tax filing.  This may cause some taxpayers to reconsider applying to the VDP altogether.

The Grewal decision has been appealed to the Federal Court of Appeal; no hearing date for the appeal has been set.