Failure to Review can be Costly
If you pay someone to prepare your tax return, whether it be a tax preparation service or a professional accountant, you are still 100 per cent responsible for the accuracy of your return.
And, if you fail to disclose income on your return, not only will you be liable for the tax owing on this undisclosed income, plus arrears interest, but you could be hit with a "gross negligence" penalty.
This penalty can apply if you knew or, "under circumstances amounting to gross negligence," ought to have known that income should have been reported on your return.
The penalty is generally equal to 50 per cent of the understatement of tax payable related to the omitted income.
The gross negligence penalty was the subject of a recent Tax Court decided this summer involving a taxpayer who failed to report, on his 2007 tax return, nearly $19 million of taxable dividend income paid to him by two holding companies.
The omitted taxable dividends were detected during a Canada Revenue Agency audit of the taxpayer's holding companies three years later.
The issue before the court was whether the taxpayer was "wilfully blind to indications, alerts or precautions which would have disclosed this admitted dividend income reporting error."
The evidence showed that the taxpayer "was deeply involved in the declaration, calculation, payment and receipt of the dividends." Indeed the taxpayer even set aside $4.725 million by investing in a financial instrument with a maturity date at the end of April 2008 (coinciding with the balance due date for tax owing for 2007) to facilitate paying the associated tax on the dividend.
In his defence, the taxpayer argued that his return was "entirely prepared, reviewed and filed by (his) trusted, longstanding accountants." Nonetheless, he admitted that he neither read nor reviewed his tax return before signing it. In court, the taxpayer's lawyers argued that he "had good reason or excuse not to read his return: he trusted his long-standing accountants."
The taxpayer testified that in prior years he always read his tax returns during a face-to-face meeting with his accountant before he signed them but failed to do so in 2007. Instead, in 2008, they met by telephone, "without the benefit of the completed tax return before either of them."
Ultimately, the returns were signed in what the Judge referred to as a "drive-by signing," which occurred while the accountant's taxi waited outside the taxpayer's home as he "was leaving town in short order."
In upholding the gross negligence penalty, the judge said that the taxpayer "averted his eyes to any possible warning: he did not read his tax return: none of a draft, a copy or the one he signed. In combination with the other suggestive signs and circumstances, this aversion was wilfully blind to a critical and mandatory act which would likely have led to detection of the omission."
As John Sorensen, a tax partner in Gowling WLG's Toronto office, wrote in a recent blog post: "The take-away from this case is straightforward ... failing to take the obvious step of reviewing a return coupled with later ignoring warning signs of a potential error will support gross negligence penalties."