Twice bitten

Advisor's Edge

2011-05-01


Double check your returns even if prepared by a pro

In matters of tax compliance, such as filing on time or ensuring you properly report all your income or ownership of foreign income-producing assets where the cost amount is above $100,000, the penalties for not properly following the rules or for negligence are severe.

Fortunately, if your client has a good excuse, he may sometimes be able to throw himself at the mercy of the Canada Revenue Agency under what’s become known as “fairness rules.”

The fairness legislation gives the CRA the discretion to cancel or waive all or a portion of any interest or penalties payable. However, it doesn’t exempt the actual taxes owing.

To use the fairness doctrine, the penalties and interest charged for late filing or late payment of taxes must have resulted from circumstances beyond your client’s control. These can include natural disasters, a serious illness or accident, or serious emotional or mental distress such as a death in the family.

To apply for relief, your client needs to send a letter to the CRA. The letter should contain her name, address and social insurance number, the tax year(s) involved and the facts and reasons why any interest or penalties charged were caused by factors beyond her control. Be sure to include any relevant receipts, documents or correspondence, including medical evidence. If her request for fairness relief is turned down, she can request a second review by the director of the tax centre or district office. Failing satisfactory resolution, she can apply to the courts for a judicial review.

While the court does not have the discretion to directly reverse the CRA’s decision, it will determine whether the CRA has “exercised its discretion in a reasonable and fair manner.”

A recent case decided in April 2011 (Spence v CRA, 2011 FC 426) involved taxpayer Ian Spence, who hired H&R Block to prepare his 2006 personal tax return. H&R Block completed the return and asked Spence to come to the office to sign it, before it was sent to the CRA for processing. He visited H&R Block in late February 2007 and learned his refund was just over $2,500, which was about the amount he was expecting. As a result, he did not actually review his printed return before signing and filing it.

In early March 2007, Mr. Spence received his Notice of Assessment in which his return was indeed assessed as filed and received his $2,500 refund. About a year later, however, in April 2008, the CRA sent Mr. Spence a Notice of Reassessment which informed him the amounts he reported on his 2006 return were incorrect in that he failed to include about $36,000 in income as well as approximately $9,000 in taxes withheld at source.

Once his return was recalculated, however, it turned out that the refund he received was too high and he was asked to repay $124 back to the CRA, which he did immediately. Unfortunately, the story didn’t end there [DASH] the CRA assessed Spence penalties and interest amounting to $7,625 for his failure to report income.

The amount of the penalty was equal to 10% of the amount of income unreported and applies when someone fails to report income more than once in a four-year period. As it turns out, Spence had previously omitted “a small amount of income” on his 2004 return.

Spence challenged the penalty under the fairness provision of the Act, as discussed above. He argued the penalty was “disproportionately large, given that he had acted conscientiously to file his return in a timely way.” In fact, H&R Block admitted that it had made the error and not Spence.

Notwithstanding this, the CRA denied Mr. Spence’s request for relief on the basis that “he had not shown […] extraordinary circumstances.”

In 2010, Spence first appeared in Federal Court seeking judicial review of that decision and was successful (Spence v Canada (Revenue Agency), 2010 FC 52). Justice John O’Keefe sent Spence’s request back to the CRA for reconsideration, which turned him down again, finding it would be inappropriate to cancel the penalty since it was Spence’s responsibility to ensure his tax return was accurate, even if completed by a third party.

As the CRA stated, “Mr. Spence had two opportunities to correct his return [DASH] before signing it, and after receiving his first notice of assessment in March 2007. The omissions would have been clear to him if he had taken the time to look at those documents.”

Thus, Spence found himself in Federal Court for the second time this past April (2011), seeking judicial review of the CRA’s second rejection of his relief request. He argued the CRA’s decision was “unreasonable in his circumstances, especially since he did not conceal any income or gain anything by failing to submit a fully complete tax return.”

Unfortunately, the Judge was unsympathetic, writing, “I can find no basis on which to overturn the (CRA’s) decision. I must, therefore, dismiss this application for judicial review.”

This is clearly a most unfortunate result for Spence and serves as an important reminder that our clients and we must meticulously check our returns before submitting them, even when prepared by a tax professional.