What Is A Gross Negligence Penalty?

Under subsection 163(2) of the Income Tax Act (ITA), the Canada Revenue Agency (CRA) may impose a gross negligence penalty when a taxpayer, knowingly or under circumstances amounting to gross negligence, makes a false statement or omission in their tax return. The Excise Tax Act (Canada) contains a parallel provision (section 285) that authorizes the CRA to impose similar penalties for GST/HST.

Gross negligence penalties are intended to deter taxpayers from deliberately underreporting income or inflating deductions and credits. In theory, the CRA should impose these penalties sparingly and only in the most egregious cases. In practice, however, the CRA often applies them whenever it disagrees with a taxpayer’s original filing position or discovers unreported income.

Elements of a 163(2) Penalty

1. A False Statement or Omission

The CRA must identify a false statement or omission in a tax return. This could include:

• Underreporting income (e.g., failing to report business or investment income).
• Overstating expenses or deductions (e.g., claiming personal expenses as business expenses).
• Claiming ineligible tax credits (e.g., making up fictitious donations).
• Failing to report offshore assets or income (if required under the Foreign Income Verification Statement (T1135)).

2. The False Statement or Omission is Made “Knowingly” or Due to “Gross Negligence”

The CRA must prove that the taxpayer acted:

• Knowingly – the taxpayer was aware they were making a false statement.
  
• With Gross Negligence – the taxpayer showed extreme carelessness or willful blindness in preparing their tax return. The courts have defined gross negligence as a high degree of negligence beyond simple errors or mistakes.

How Is the Penalty Calculated?

If the CRA applies a 163(2) penalty, it is equal to:

• 50% of the understated tax or 50% of the overstated credits, whichever is greater.

Example 1: Underreported Income

• A taxpayer earns $200,000 but only reports $150,000, avoiding tax on $50,000.
  
• If the tax payable on the missing $50,000 is $15,000, the penalty would be: 50% of $15,000 = $7,500 penalty.

Example 2: Falsely Claimed Expenses

• A taxpayer inflates business expenses by $30,000, reducing their taxable income.
  
• If this false deduction resulted in $10,000 less tax owed, the penalty would be: 50% of $10,000 = $5,000 penalty.

Defending Against a Gross Negligence Penalty

Taxpayers can dispute a gross negligence penalty by making some of the following arguments:

1. The false statement was an honest mistake
2. The taxpayer relied on a professional tax advisor when reporting their income
3. The taxpayer’s reporting position was reasonable in the context of their profession, level of experience, and education 
4. The CRA has not met its burden of proof to impose the penalty