Gross Negligence When Spouse is Tax Preparer
Hine v The Queen, 2012 TCC 295
There are two matters in this case that are of interest:
- The analysis as to whether gross negligence penalties pursuant to subsection 163(2) of the ITA were warranted in this case; and
- The analysis as to whether enhanced costs were appropriate in light of a purported offer to settle by the Taxpayer- Rule 147(3)(d) TCCRGP.
Justice Hesfield for the TCC held that in the circumstances of this case the tax preparer was not grossly negligent, and that the Taxpayer’s reliance on the taxpayer (even blind reliance) would not be unreasonable. Here the tax preparer had detailed kowledge of the busienss, had made inquiries (including from the CRA), was dilligent, and made an error due to time pressure and a confusing trust ledger.
The Court further held that the purported offer to settle was not an offer to settle, and even if it was an offer, it was not one that could be accepted by the Crown – therefore no reason for enhanced costs. None of the other factors in subsection 147(3) of the TCCRGP were present, and the taxpayer had not demonstrated exceptional circumstances that would justify enhanced costs.
[Note that the Court here is looking for exceptional circumstances to grant costs beyond the tariff rate, while the court in Velcro Canada Inc v The Queen, 2012 TCC 273, after reviewing the rules, stated that no special circumstances are needed for the TCC to grant costs above tariff rates]
The Taxpayer failed to report $157,965 in business income on his 2006 income tax return. The MNR assessed and tacked on gross negligence penalties pursuant to subsection 163(2) of the ITA. The taxpayer embarked on a new business of flipping homes starting in 2005. HE flipped three homes in 2005 and 2006, and the income not reported is in relation to one of those properties.
The proceeds of sale of the one property were applied to the purchase of another property, without the taxpayer receiving the funds (stayed in lawyer’s trust account). The taxpayer’s lawyer’s trust account ledger showed the closing receipt from the understated property less than the actual amount, the difference being the understated amount, and equal to the mortgage outstanding on the home.
The taxpayer’s spouse prepared the tax returns. She did not receive the lawyer’s statement until days before the April 30, 2007 deadline, and relied on it as the proper net reportable amount for the sale of the property. This was based on her understanding based on a conversation with the CRA that the mortgage payments reduce the taxable gain, combined with her confusion as to what the trust ledger stated, resulting in double deduction of the mortgage amount and resulting in a loss for the 2006 tax year. She did not appreciate that she had deducted the mortgage twice until the audit.
The Spouse contacted CRA multiple times, spoke to the City’s Business Bureau, their relator and their accountant to determine the proper way to report the income generated from the new business venture. Eventually she spoke to a CRA agent who described the nature of the gains and the expenses that could be deducted. She made notes of the conversation at the same time it occurred, and referred to the notes when giving evidence in court. She meticulously used an excel sheet to record income and expenses.
The Court noted that:
Ms. Prevost testified that the audit of the Appellant’s 2006 taxation year started in April 2008 and in spite of her total cooperation, a ready acknowledgment of her mistake and assurances by the CRA that there would be no penalties, there was a long delay in the processing of the reassessment which was issued, with penalties, in June 2009. The tax arising from the reassessment was less than $5,200 and the gross negligence penalty was $28,111.
The Crown argued that the loss in 2006 was substantial and was in sharp contrast to the previous year, making the claim of ‘innocent mistake’ hard to accept. The fact that the taxpayer knew he had a large gain in 2006, makes the reporting of a large loss such that it should have alerted him to a mistake. There was similarity between the events in 2005 that were properly reported, and those in 2006. Thus, the taxpayers “either knew they were misrepresenting the income from the sale of the Greyrock property, ought to have known, or, wilfully turned a blind eye to circumstances that demanded further clarification, if not correction.”
The Taxpayer argued that they were very cautious in recording and reporting for tax purposes. When looking at the return, line 236 does not show a loss but Nil income, which when ultimately assessed went from Nil tax payable to $5,200. Thus, there was nothing glaring to raise a red flag. The trust account statement was confusing and the taxpayer’s spouse honestly believe she was reporting the gain properly based on the information on the statement. The taxpayer also argued that for the gross negligence penalty something more than the failure to use reasonable care is required, such that ” a reasonable man not noticing a mistake does not make for gross negligence.”
The Taxpayer argued, based on Farm Business Consultants Inc. v. Canada, 1994 CarswellNat 1107, that the Court should be extremely cautious in imposing penalties. Something more than a mere probability of misconduct is required, and the taxpayer should get the benefit of any doubt. The Court noted that the SCC in .H. v. McDougall, 2008 SCC 53, that in civil cases there is only one standard of proof – namely a balance of probability. The Respondent if not raise that case, and expressly accepted the standard of proof expressed in Farm Business Consultants. The Court said at paragraph 26:
Still, it might be worth mention that it strikes me that there are distinctions to be made with respect to the standard of proof applicable to subsection 163(2). It is arguably a quasi criminal provision that should be viewed differently and, in any event, requires that a distinction be made between negligence and gross negligence. As such, it may be less a question of changing the standard of proof than changing the focus. The focus is on determining the sufficiency of evidence to establish whether conduct of an appellant is “gross”. It strikes me that the subsection 163(2) cases underline little more than the obvious which is that the Crown needs better evidence to come within the scope of this penalty provision than it would to establish mere negligence. In that context, I will not depart from the manner in which this Court has consistently viewed subsection 163(2) – namely that it requires a greater standard of proof.
The Taxpayer argued that the failure to report a large amount does not in itself mean that there’s been gross negligence – Hyndman v. R., 2004 TCC 641 and Gallery v. R., 2008 TCC 583, and also that if there is negligence on part of the tax preparer, it cannot be here attributed to the taxpayer – Findlay v. R., 2000 DTC 6345 (FCA). Also, relying on Down v. Minister of National Revenue,  2 C.T.C. 2027 (T.C.C.), it was stated that the ” failure to study and understand his return is merely negligent conduct and not grossly negligent.
The Court distinguished the case of Hougassian v. The Queen, 2007 TCC 293, stating that in that case it was the taxpayer’s indifference in abiding by the tax laws that condemned him to the penalty. No indifference was shown in this case.
The Court said that the Crown “successfully and competently painted a picture that raised logical suspicions about whether the Appellant’s spouse and the Appellant himself, knew what they were doing when they misrepresented the income in the subject year”, however, the Court was not satisfied that the taxpayer or his spouse were indifferent to reporting the income correctly. There was sufficient evidence that they tried to be accurate and diligent in reporting their income. The Court accepted that there was honest confusion leading to a mistake.
Hershfield J commented that the cases dealing with errors by tax preparers did not completely apply to the circumstances, since the preparer was the spouse of the taxpayer and she did not hold herself out to be a professional tax preparer. However, in these circumstances, the court did not think that the attribution question ought to be considered differently than in cases where the taxpayer and the tax preparer were not so closely related.
He noted that attributing the gross negligence of an agent to a taxpayer involves a deliberate and intentional consciousness on the part of the principal to the act done, and that the cases are fact specific in looking at either the knowledge of the tax preparer’s negligence, or circumstances that would show the need for further inquiry by the taxpayer.
The Court held that the taxpayer’s blind faith in this tax preparer spouse was justified, and his belief that the return was prepared properly was not unreasonable. The Spouse was held not to have been grossly negligent or wilfully blind, and the taxpayer was held not to have been grossly negligent for not questioning the spouse. The Court made note that the taxpayer and his spouse cooperated fully with the auditor and readily admitted the mistake.
In dealing with the gross negligence penalty question the Court stated, before concluding that the penalty was not warranted, the following:
 Before closing, I wish to note that there is no express requirement in the Act that the person who knowingly makes a false statement must intend or understand that the consequences of making that false statement will result in a tax savings. So, for example, if I overstate expenses on one line of a return and then effectively eliminate that line by subtracting it out on another line as, say, a personal expense, then strictly speaking there has been a misrepresentation in my return. However, there will be no penalty since there will be no difference between the tax that would have been payable had the misrepresentation not been made and the tax payable if the return had been accepted as filed.
 Still, if one does not intend a reduction in tax then it might be harder for the Crown to establish that the misrepresentation, if not intentional, was made under circumstances that amount to gross negligence. This aspect of the present case troubles me.
 The misrepresentation here, made by the Appellant’s spouse in the preparation of the Appellant’s return, did save some tax. However, it is a relatively small amount compared to the amount of the imputed tax saved amount against which the penalty is assessed. The misrepresentation is, on the other hand, a very large amount, creating a large loss and thereby seemingly creating a “shelter” to protect large amounts of taxable income in other years by virtue of loss carry-backs and carry-forwards. However, there is no evidence the losses were ever used in this way. Although the assessment in question was done relatively quickly there is no evidence that the Appellant made any attempt to use that shelter. The Crown’s burden of proof might, arguably, include bringing evidence, if it exists, that the shelter was more than a simple mistake as shown by other tax returns such as amended prior years’ returns and/or subsequent years’ returns, that demonstrate the avarice resulting from the so-called “mistake”. However, it is possible in this case that any avarice intent, if it existed, would not have been acted upon given that the subject audit started in April 2008.
 That being the case, I do not draw any inference from the Crown’s failure to bring evidence on this aspect of this case. However, I simply want to draw attention to the point that the provision in the Act (subsection 163(2.1)) that deems that reported income cannot be less than nil is there to ensure that the penalty is assessed as if the full loss had been available to save tax in the year the false statement was made. The policy and wisdom of that penalty is not questionable. Setting up losses that were not incurred by reporting false costs or false proceeds might well best be prevented by not giving any weight to whether there was any attempt to use the loss. But surely the absence of evidence that the taxpayer intended the reduction in tax afforded by the creation of a loss might properly inform the question of whether the circumstance of the case were such that the making of the false statements amounted to gross negligence or to turning a blind eye to the truth of the statement.
The Court then went on to deal with the submissions as to costs. The taxpayer was seeking Solicitor-client or substantial indemnity costs on the basis that an offer to settle was made by the Taxpayer, with reference being made to paragraph 147(3)(d) of the Tax Court of Canada Rules (General Procedure). This rule allows the court discretion in determining the amount of costs, and one consideration that may be considered in any offer of settlement made in writing.
Hershfield J noted that the purported offer to settle set out factual submission and arguments and stated that the case for assessing penalties is unsupported and ought to be waived. The letter offers to settle the matter, without costs, if the MNR agrees to vary the assessment accordingly. The letter also stated that solicitor-client costs would be sought if the appellant was successful at trial.
The Court accepted that the essence of the “offer” was to abdicate the appeal – and an offer for the other party to withdraw in order to avoid a threat of enhances costs cannot be considered an “offer of settlement” in the circumstances. The Court was concerned about the circumstances, being that even if the offer was an offer to settle, it was not open for the MNR to accept the offer. The Court stated:
 It was acknowledged that the only issue at trial was whether Mr. Hine was grossly negligent. That question fits into the “yes-no” category described by Justice Stratas in CIBC World Markets Inc. v. R., 2012 FCA 3. There are no degrees of gross negligence. Objective considerations supported the Respondent’s view that showing a loss as opposed to disclosing a substantial gain warranted a hearing to assess the weight and probability of self-serving evidence.
 The assessment at issue was not a routine imposition of penalties. Indeed, based on the case presented by Respondent’s counsel, I am satisfied that the assessment was based on a thoughtful and not unreasonable belief that the Appellant must have known of the misrepresentation in question. To have “settled” the case as offered by the Appellant would have been to abdicate the responsibilities imposed on the Department of Justice. There was, in these circumstances, an impediment to settlement tantamount to a legal impediment. There is nothing in the authorities, including my decision in Potash Corporation of Saskatchewan Inc. v. R., 2012 TCC 235, to suggest otherwise. Determining whether the Appellant’s conduct in this case was wilful or wonton or grossly negligent could not be conceded in this case on the basis of what a court was likely to find on a balance of probability. The objective evidence pointed in a different direction.
 As well, I note that none of the other factors in subsection 147(3) warrant my awarding enhanced costs in this case. The amount at issue, the tariff versus the fees incurred and the circumstances of the case are not such to cause me any alarm that a grave injustice has been suffered by the Appellant in terms of a cost award governed by the applicable tariff. The law is well settled in this area. Further, its importance is singular to this appeal and there are no complexities that warrant special consideration. There was nothing in the time required by Appellant’s counsel (some 30 hours) that would suggest that the volume of work was such to create an expectation that an enhanced cost award would be justified. As to the conduct of the parties, the Respondent did not require examinations for discovery and the Appellant did not request same. The Respondent did not oppose the Appellant filing an amended list of documents some 45 days prior to the hearing. There was nothing denied that ought to have been admitted. There was no conduct that could, in any way, be described as inappropriate and the Appellant has not demonstrated any exceptional circumstance that would justify an enhanced cost award.
 Accordingly, the Motion for enhanced costs is dismissed.
[OBSERVATIONS From Mr. James Rhodes]
My issue with this judgment is that it seems to indicate that the DOJ does not have to (and perhaps should not) consider settlement offers in these ‘yes/no’ categories because the Court will not consider them should the App be successful. To me, this effectively means that no settlement offers will be ever be made in these ‘yes/no’ categories, such as gross negligence penalties, because the App has nothing to gain by offering a compromise, and the Resp has nothing to lose by rejecting attempts to compromise (should the App be successful in its appeal).
My worry would be that this decision has effectively either created a non-settleable category of appeals or has created a pigeon hole list of issues where attempted settlement offers will not considered for the purposes of paragraph 147(3)(d). And if this conclusion is correct, that would seem to go against the expansive wording of paragraph (d) which states [in exercising its discretionary power to award costs, the Court may consider] “any offer of settlement made in writing”.
Following on the above, I disagree with the learned Justice relying upon the DOJ’s legal responsibilities as the reason they could not and should not have considered the settlement offer. As the DOJ has the same legal responsibility in the carriage of all appeals to the Tax Court, I do not understand why that legal responsibility prevents them from considering the merits of the appeal in yes/no category appeals versus all other appeals. If the DOJ has an expenses related appeal, are they not faced with the consideration of whether they can prove their case to establish the correctness of the assessment? And where they accept a settlement offer in an expenses case, are they still not exercising their legal responsibility? And so if there is only one expense at issue does that suddenly mean they cannot consider a settlement to allow the appeal in exchange for the App not seeking costs because it is now a ‘yes/no’ issue? And this is not considering the fact that the Resp bears the onus to prove the correctness of the assessment of penalties vs. an expense appeal where the App bears the onus.
The other issue I have with this appeal is that it treats the appeal as if only one issue was at stake – that issue being whether the App was correctly assessed for gross negligence penalties. However, going on the assumption that both the App and the Resp, as part of their pleadings, also sought to be awarded costs, the Court had two issues to decide. The second issue being whether one of the parties should be liable for others costs, and what amount those costs should be. And as an unsuccessful party can be awarded costs to be paid by the successful party, there is no guarantee the successful party will be awarded costs.
When I read this decision, I do not understand why it was not valid for the App to offer to give up seeking success in the second issue (costs) in exchange for the Resp agreeing to the App being successful in the first issue. If the gross negligence penalty amount was $1k, but the possible tariff costs were $3k, is that not a successful resolution for the Resp? And if the Resp rejected the settlement because it believed it had a strong case, but turned out it did not, why should it not be held liable for increased costs for turning down what would have otherwise been a successful resolution?
In the end Justice Hershfield considered the other factors in ss. 147(3) of the GPR. I would have preferred if he viewed the settlement offer as being valid, and considered it along with the other factors. As the reality is that the settlement offer did not have a lot of compromise in it by the App, he could have given it minimal weight as a factor supporting an increased award of costs. Given his other findings at paragraph 61, his conclusion would be warranted.
Sas Ansari, BSc BEd PC JD LLM PhD (exp) CPA In-Depth Tax 1, 2 &3
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