Tax season is behind us, so most Canadians need not worry about their tax returns again until the spring of 2021, when the 2020 returns are due. But if you’ve “forgotten” to report income on your 2019 return, you may want to take some time over the summer to request an adjustment to your return, lest you face a penalty of up to 10 per cent of the unreported income.
Under the Income Tax Act, if you fail to report at least $500 of income in a tax year and in any of the three preceding taxation years, the “repeated failure to report income” federal penalty will be the lesser of 10 per cent of the unreported income and 50 per cent of the difference between the understatement of tax (or the overstatement of tax credits) related to the omission and the amount of any tax paid in respect of the unreported amount, for example, by an employer through source deductions withheld. A corresponding provincial 10-per-cent penalty is also often assessed.
Prior to 2015, however, there was no $500 income limitation for the penalty to apply and the penalty was not limited to 50 per cent of the tax resulting from that income (less any tax withheld on it.)
This came up in a recent case decided earlier this month in Tax Court involving a Toronto cosmetician who was hit with a penalty for failing to report $27,497 of income on her 2012 tax return. Her unreported income consisted of $27,236 on a T4A slip from a real estate brokerage, and approximately $261 of income from two mutual funds, reported on T3 slips.
The $27,236 of income was related to the taxpayer’s purchase of four condominium units in the heart of Toronto’s Entertainment District. She stated that these units were purchased about three years prior and were bought with the intention of renting them out.
The taxpayer used the services of a realtor to make the purchases. The realtor indicated he would pay her a sum of money in exchange for purchasing the properties through him. This is known in industry parlance as a “real estate commission rebate,” or, in the common vernacular, a kickback.
She testified that she pressed the realtor for the payment for about a year, at which point she received the $27,236. She stated that she was not told a T4A slip would be issued with respect to the payment and that upon receiving the payment and the subsequent T4A slip, she did not report the amount in her 2012 tax return.
She testified that when she subsequently received a letter in February 2014 from CRA’s T1 Matching Program, she spoke to her accountant because she was of the view that the amount was a gift and should not be taxable. In cross-examination, she stated that she believed the real estate brokerage had issued the T4A slip “in error” and that “she tried to contact them many times without success.”
As to the remaining unreported income amount of $261 for 2012, the taxpayer testified she was unsure as to whether its omission was made by her or her accountant. She stated it was such a small amount that she likely did not know about it.
Unfortunately, 2012 was not the first time the taxpayer forgot to include an amount in her income. In 2011, the CRA reassessed the taxpayer for unreported income totalling nearly $7,800, also from some mutual funds. Asked in cross-examination about the unreported income amount for 2011, the taxpayer testified she would not intentionally have failed to report it.
Because she failed to report an amount in income in both 2011 and 2012, the CRA assessed the repeated failure to report income penalty.
Technically, if income wasn’t reported in two years out of four, the penalty will automatically apply. But at the 2012 Ontario Tax Conference, the CRA stated that a taxpayer who has been assessed this penalty can have it cancelled “if the taxpayer can show that he or she was duly diligent in either one of the two years in which the failures occurred.”
There are two ways to establish due diligence: if the taxpayer made a “reasonable mistake of fact,” or took “all reasonable precautions” to avoid the event leading to the penalty.
With respect to the commission rebate, the taxpayer referred to it as a “kickback, a benefit, and a gift.” A cursory Google search for the term “real estate commission rebate” took me to the website of the Real Estate Council of Ontario’s website. Under the all-caps heading “PROVIDING REBATES MAY HAVE TAX IMPLICATIONS,” the site suggests brokers and agents “advise your clients and customers that there may be tax implications and to seek professional advice.”
The judge reviewed the circumstances that led to the commission rebate and concluded that in purchasing the condos for rental, the taxpayer had a “source of income from a business or property and that the (real estate commission rebate) is income from that source.”
As a result, the rebate should have been reported as taxable income. Accordingly, there was no mistake of fact. Rather, the taxpayer didn’t report the rebate because she believed it was non-taxable, which was a mistake of law and does not support a due diligence defence. Further, the judge held that the taxpayer had not taken all reasonable precautions to avoid As for the remaining $261 of unreported income, the taxpayer stated “the amount was so small that she probably was unaware of it.” Since she received the T3 slip, she should have reviewed her return for completeness prior to filing.
“There was no evidence to support either a reasonable mistake of fact or that all reasonable precautions were taken to avoid the failure to report these T3 amounts,” the judge wrote in upholding the penalty. “There is a general lack of attentiveness that appears to have led to similar omissions (i.e. for the T3 income) in 2011 and 2012, and the repeat nature is the essence of the … penalty.”