Blue J Legal is thrilled to announce a valuable new resource: primers. Primers complement Classifiers and Case Finders by providing a short summary of the law, key concepts, and relevant considerations in each area covered. They draw on traditional legal research and insights gained from Tax Foresight’s case law data and machine learning algorithms. Below, we demonstrate how our Gross Negligence primer can be used as a roadmap for analyzing a gross negligence question. We focus on a recent case, McLeod v. The Queen, 2017 TCC 192 (“McLeod”).
Overview of McLeod
The Minister assessed the taxpayer for $223,250 of unreported income for the 2008 taxation year and gross negligence penalties of $31,698 under subsection 162(3) of the Income Tax Act. Subsection 163(2) applies when a person knowingly, or in circumstances amounting to gross negligence, made, participated in, assented to or acquiesced in the making of false statements or omissions in their tax filings.
The false statement in McLeod’s personal income tax return was the omission of a management fee received in the context of the sale of his company, OK Blueprinting (“OK”). While he failed to include the management fee in his income, he did include it in the income of a previous venture, Mongo’s Grill, Ltd. (“Mongos”) that had significant business losses. This structuring of proceeds thus reduced any tax liability that would have arisen by including the management fee in his personal income. Justice Pizzitelli found that there was no agreement for Mongos to be paid a management fee, and that the alleged agreement was “fabricated” to use the losses in Mongos and remove funds tax-free from the same company by drawing from his shareholder’s account.
Roadmap of the Analysis in McLeod
How did the court arrive at its decision? The Gross Negligence primer can shed light on how a court may analyze a gross negligence case. While each case hinges on its particular facts, the primer identifies the most relevant factors based on the entire body of jurisprudence on the question. These factors can be grouped into considerations on:
Sophistication of the taxpayer;
Characteristics of the tax preparer;
Red flags calling for further inquiry;
Actual inquiries by the taxpayer; and
In McLeod, the court’s reasons for decision focused on the sophistication of the taxpayer, the characteristics of the tax preparer, and red flags calling for further inquiry.
Sophistication of the Taxpayer
Justice Pizzitelli noted the taxpayer's level of education, business experience, and mental state. While McLeod's level of education (grade 10) did not necessarily convey a high level of sophistication, his experience operating a restaurant business and mechanical repair proprietorship was a factor in the finding of gross negligence. This business experience led the court to conclude that McLeod was aware of the need to file accurate tax returns.
The primer notes that circumstances affecting a taxpayer’s cognitive ability can lead to a finding that the taxpayer was not grossly negligent. In fact, Tax Foresight’s case data indicates that where the taxpayer has been incapacitated with a mental illness, the court has never found gross negligence. McLeod had a previous head injury, but it was not sufficiently documented to support the suggestion that it affected his testimony or his actions.
Characteristics of the Tax Preparer
McLeod’s accountant initially recommended the structuring of proceeds that led to the misstatement, but reliance on such professional advice did not exonerate McLeod. Ultimately, McLeod chose to proceed with the course of ill-advised action.
The primer notes that a less sophisticated taxpayer may not be expected to recognize poor accounting advice. In this case, McLeod’s extensive business experience likely precluded him from making such a defence successfully.
Red Flags Calling for Further Inquiry
As the primer notes in its roadmap, the magnitude of the misstatement is an important consideration. In this case, McLeod’s omission resulted in him misstating his income by 285 percent. McLeod had also faced earlier assessments of gross negligence penalties and should have been aware of the consequences for not complying with requirements. In light of these factors, the court noted that even if McLeod had not knowingly participated in the misstatement, he would still have been found grossly negligent.
Current Library of Primers
- Gross Negligence, pursuant to subsection 163(2) of the Income Tax Act
- Shareholder Benefits, pursuant to subsection 15(1) of the Income Tax Act
- General Anti-Avoidance Rule, pursuant to section 245 of the Income Tax Act