The Tax Court of Canada recently released its decision in Hansen v. The Queen, 2020 TCC 102, the latest in a quickly growing body of caselaw dealing with “house flips”. The case dealt with a taxpayer, Mr. Hansen, who had sold five properties in six years, between 2007 and 2012. Mr. Hansen had claimed the principal residence exemption in respect of all five sales. The Tax Court’s decision is particularly interesting because it illustrates the different burdens of proof on the Canada Revenue Agency (the “CRA”) for justifying reassessments of “statute-barred years” and gross negligence penalties in the context of house flips.
As additional background, Mr. Hansen and his family lived in each of the five properties for under a year. Mr. Hansen testified that he made improvements to each home to suit his family and that in each case, they had compelling reasons to sell and move on to the next home. Perhaps most importantly, Mr. Hansen also testified that he informed his accountant of all the property transactions, including his intentions for each property and the reasons for sale, and that the accountant advised the principal residence exemption applied. His accountant corroborated his testimony at trial.
In this case, three of the five property sales occurred between 2007–2010, and these years were outside the “normal reassessment period”, as defined by subsection 152(3.1) of the Income Tax Act (Canada) (the “Act”)—commonly known as statute-barred years. In order to reassess a statute-barred year, the CRA must prove that (1) the taxpayer made a misrepresentation in his or her tax return; and (2) this misrepresentation was attributable to neglect, carelessness, wilful default, or fraud.
The Tax Court cited longstanding caselaw that there is no negligent misrepresentation where, at the time of filing the return, the taxpayer carefully considered his or her position and filed on a basis that he or she believed, in good faith, to be correct. This is the case even if the CRA disagrees with the taxpayer’s position, and even if the taxpayer’s position is ultimately found to be incorrect by the Tax Court.
Here, the Tax Court found that Mr. Hansen had carefully assessed his situation and filed his returns based on a reasonable and honest belief that he was entitled to claim the principal residence exemption. The Tax Court emphasized the involvement of Mr. Hansen’s accountant as strong evidence that Mr. Hansen took the necessary steps to file his tax returns on a reasonable basis. As a result, the Tax Court held that the CRA was not entitled to reassess Mr. Hansen for the statute-barred years, and overturned those reassessments.
Gross Negligence Penalties
The Tax Court upheld the CRA’s recharacterization of the sales of Mr. Hansen’s properties in 2011 and 2012 (which were not statute-barred) from capital gains to business income. That determination largely depended on the circumstances surrounding those sales—the two homes were always intended to be temporary stays because the Hansens had purchased another lot and were waiting to build a new home there.
The Tax Court then considered whether to uphold the gross negligence penalties the CRA imposed on these two sales. Under subsection 163(2) of the Act, gross negligence penalties apply when a taxpayer knowingly, or under circumstances amounting to gross negligence, has made a false statement or omission in his or her tax return.
The Tax Court emphasized that “gross negligence” implies a high level of misconduct, and found that Mr. Hansen’s conduct was, to the contrary, that of a reasonable person. Once again, Mr. Hansen’s reliance on his accountant was key. The Tax Court gave weight to the evidence that Mr. Hansen had provided his accountant with all the necessary information prior to the accountant advising that the principal residence exemption applied. The Tax Court therefore overturned the gross negligence penalties.
The key takeaways from this decision are:
- In recharacterizing the proceeds of property sales from capital gains to business income, the CRA will often point only to the number of sales and the length of time the property was held, but these are not the only factors. In this case, with five sales in six years, the taxpayer was still able to achieve significant success.
- There is significant scope for a taxpayer to succeed on statute-barred years and gross negligence penalties even if the taxpayer fails on the characterization of the property sale. These issues should always be carefully considered in any case involving a relatively short timeframe between purchase and sale of a house.
- Reliance on an accountant in filing tax returns can carry significant weight in this type of case. Taxpayers should provide their accountant or other tax advisor with all relevant information regarding real estate transactions prior to completing their tax returns, and consider doing so in writing (or at least retaining notes from meetings or calls) for evidentiary purposes. Calling those advisors to testify at trial and provide supportive testimony, if necessary, could also be critical.