163(2) Gross Negligence Penalty

Volume No. 06-22

“Can an accountant’s gross negligence transfer to the client?.”

In the Finley case (1997 TCC 615), the taxpayer decided to incorporate his video business using the rollover provisions of section 85. The transfer of goodwill resulted in capital gains. The taxpayer failed to report the capital gains resulting on the transfer of goodwill in his personal income tax return. The Canada Revenue Agency (“CRA”) assessed the gross negligence penalty for the omission of the capital gain on the taxpayer’s return and for failing to provide an explanation for this omission.

The taxpayer had been in business since 1983 and had a grade 13 education. He always had an accountant or a friend prepare the accounting records of the business, as well as the taxfilings. For the year in question, the taxpayer relied on the expertise of the accountant, signed the return without review, and filed it with the CRA.

The taxpayer had discussed the tax implications of incorporating his business using section 85 of the Act with his lawyer and accountant. It was his understanding that incorporating his business using the provisions of section 85 would not generate any tax.On the advice of his lawyer, the taxpayer incorporated his business. All the required filings associated with the incorporation of the business (i.e., Form T2057), the corporate income tax return and the taxpayer’s personal tax return were filed on time.

The CRA’s position was that the taxpayer was advised of the requirements under the Act with respect to the incorporation of his business and he failed to ensure the accuracy of his returns. Had he reviewed the returns, he would have known that the capital gain was missing.

The Tax Court ruled that:

  1. The taxpayer had no knowledge that the capital gains were omitted from his return, as he believed no tax was generated from incorporation of his business;
  2. The error committed by the accountant amounted to gross negligence as theaccountant had knowledge of taxpayer’s business affairs and was party to the transaction; and
  3. The actions of the accountant are attributable to the taxpayer, and the taxpayer was subject to the gross negligent penalty.

The Federal Court of Appeal ruled in favour of the taxpayer and said that the Tax Court judge erred in the findings that the actions of the accountant were attributable to the taxpayer. The Federal Court found that the taxpayer had no knowledge of the errors committed by the accountant and that the gross negligence of the accountant was not attributable to the taxpayer. Accordingly, the Federal Court set aside the decision made by the Tax Court.

This case rightfully determined that a taxpayer cannot be responsible for the errors committed by the accountant, especially where the taxpayer had no knowledge of that error.


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