Conventional and unconventional avenues to coax the CRA to fix its own errors

By Felix Wu, Associate, and Milosz Zak, Associate, Farber Tax Law

No one is perfect. Just as much as the Canada Revenue Agency (the “CRA”) harps on taxpayers to correct their errors and may audit to protect the tax base, the CRA is not impervious to making mistakes. It goes without saying that in instances where the CRA error is both material and to the financial detriment of the taxpayer, it is important to put in motion the right approach to coax the CRA to fixing its own mistakes. Some errors are mechanical in nature and derive from the CRA’s many departmental asymmetries, some are human errors, and some are deliberately sanctioned adjustments of convenience, such as grossly inflated income following an audit. Quite simply, when faced with CRA error, using a sledgehammer to crack a nut may not only be ineffective but also cause a taxpayer to miss an opportunity to arrive at a speedy resolution.

It is important for a taxpayer to know how best to communicate when the CRA has made an error in assessing or reassessing their return. Some situations are more common than others, but there may also be unconventional routes available to solve some specific issues.

Notices of Objection: Reverse onus in subsections 152(4) and 163(2) of the Income Tax Act

Under Canada’s self-reporting system, the onus is generally on the taxpayer to provide information to the CRA through returns and have the CRA issue assessments. In cases where the CRA disagrees with the information or the amounts on the taxpayer’s returns, the “onus” remains on the taxpayer to prove their numbers. In such instances, the taxpayer most often must resort to a formal Notice of Objection to correct the CRA’s erroneous position. However, there exists a “reverse onus” on the taxpayer within subsections 152(4) and 163(2) of the Income Tax Act¹(the “ITA”) and parallel provisions in Excise Tax Act.²

Specifically, under subparagraph 152(4)(a)(i) of the ITA,³where a taxpayer has made any misrepresentation that is attributable to neglect, carelessness, or wilful default in filing a return or supply any information under the ITA, a reassessment can be made notwithstanding the expiry of the normal reassessment period. The normal reassessment period, pursuant to subsection 152(3.1) of the ITA,⁴ is three years. For the CRA to reassess a taxpayer beyond the three-year period, the CRA must prove that a misrepresentation occurred. With that in mind, the alleged misrepresentation may have been due to the taxpayer’s neglect, carelessness or wilful default. The definition of each of these terms has been extensively litigated and refined through case law. In operation, the CRA ought to generate a “Reassessment Beyond the Normal Period Report” through the audit, which examines and reviews, among other factors:

Similarly, subsection 163(2) of the ITA ⁵ allows the CRA to levy gross negligence penalties against the taxpayer where the taxpayer “…knowingly, or under circumstances amounting the gross negligence…” makes, participates, assets or acquiesces to the making of a false statement or omission. Like the analysis under subsection 152(4) of the ITA,⁶the CRA ought to prepare a “Penalty Recommendation Report” analysing the same factors to prove that the CRA is justified in levying gross negligence penalties against the taxpayer. Note, however, that the test under subsection 163(2) of the ITA⁷is more stringent than 152(4) of the ITA,⁸as per the established case law.

In either case, the outcome is simple; a taxpayer who has been reassessed with a reassessment beyond the normal period or had gross negligence penalties applied, and has evidence to prove the CRA made a mistake, may have to file a formal Notice of Objection through a Form T400A⁹for income tax appeals or an Form GST159¹⁰for GST/HST and rebate dispute with the CRA, and request disclosure of the two reports. After analysing the reports, the taxpayer may either dispute the error or omission in its entirety or provide a due diligence defense that the error (i.e. the alleged misrepresentation) was not due to carelessness, neglect, wilful default, wilful blindness, or gross negligence.

The courts have also recognized and established that there should be a high bar in holding the CRA accountable for their ability to impose these provisions. In Venne v The Queen,¹¹the Federal Court stated that the gross negligence penalty provisions, “must be interpreted restrictively”, to avoid imposing the penalties inappropriately. Likewise, in Lacroix v Canada,¹²the Federal Court of Appeal held that if there is a viable and reasonable hypothesis that does not justify the penalty, the benefit of the doubt must be given to the taxpayer. Clearly, in instances where the CRA is wrong in concluding that there was misrepresentation, thereby allowing it to reassess beyond the normal reassessment window, or in instances where gross penalties have been applied, a taxpayer’s recourse to correct the CRA’s erroneous conclusion is the formal Notice of Objection process.

Taxpayer Relief Applications: Paragraph 26 of the “Taxpayer Relief Provisions”

In some instances, where Notices of Objection are inappropriate, or the right to appeal has already been exhausted, taxpayers may be able to apply for relief from some CRA penalties and interest. Under subsection 152(3.1) of the ITA, the CRA can provide discretionary relief up to a 10-year limitation period. Most tax practitioners are aware and most commonly seek redress of CRA mistakes through the official first and second-level taxpayer relief applications (the “TPRs”). Interestingly, however, this formal TPR process was not only beset by a tremendous backlog in applications even before the COVID-19 pandemic, it is considered a blunt instrument by more specialized CRA departments. Nevertheless, since paragraph 26 of the CRA’s IC07-1R1, “Taxpayer Relief Provisions”¹³specifically references CRA errors, there are of course instances where TPR applications are in order.

Actions of the CRA

26. Penalties and interest may also be waived or cancelled if they resulted mainly because of actions of the CRA, such as:

Case Study: Interest-bearing non-resident reassessments with “in the money” overpayment of tax

Consider a situation in which a taxpayer would ordinarily pay Part I tax as a resident of Canada and receive ordinary CRA assessments, but inadvertently becomes a non-resident of Canada. This may arise as they become stranded abroad on account of numerous COVID-19 pandemic-related travel restrictions, or because their circumstances are such that they now “reside abroad” for tax purposes. If the taxpayer still receives Canadian-sourced income, it would be subject to Part XIII tax and CRA non-resident assessment treatment, leading to a situation where an initial  overpayment of tax would occur, as the Part XIII tax may be less than the Part I tax as originally accepted and assessed. In such an instance, the Minister of National Revenue (the “Minister”) is “in the money”, in that the public purse was never out of pocket as a result of the change in circumstances, and in fact owes the inadvertent non-resident Canadian a refund of the tax they had overpaid in the relevant period.

In such a situation, while the original, incorrect, Part I assessment would be vacated entirely, the CRA’s subsequent issuance of Part XIII non-resident assessments would automatically result in a calculation of tax with interest owing, in spite of the Minister being “in the money” due to the original overpayment of Part I tax. Because the reassessment process is automatic at a local Tax Services Office, there is little input from CRA officers to catch such an error, resulting in the taxpayer having no other recourse but to file a formal TPR application with the prescribed RC4288.¹⁴The drawbacks to this approach are the lengthy timelines and the usual lack of an opportunity to address a TPR officer’s proposal, which may require the taxpayer to have to resort to a second-level review, and perhaps an even more costly judicial review pursuant to section 18.1 of the Federal Courts Act.¹⁵

The lesson learned is to watch out for CRA errors of the discretionary kind and those associated with the CRA’s automatic processes. Clearly, in instances where assessments have already been issued, the taxpayer will likely be forced to follow the formal Notices of Objection or TPR application processes established by either the Income Tax Act ¹⁶ (the “ITA”) or the Excise Tax Act ¹⁷to arrive at a resolution.

Waiver Applications: Discretionary self-help remedies for RRSPs and TFSAs

In some instances, the CRA provides for a variety of waivers to change the treatment of a transaction or to fix a CRA or taxpayer error. Registered plans like a registered retirement savings plan (“RRSP”) or a tax-free savings account (“TFSA”) are monitored by the CRA and feature waiver-driven discretionary avenues for a remedy. Both programs have set contribution limits – RRSP is based on income reported from the previous year, while the TFSA is a set limit established by the Canadian federal government in Ottawa.

In either case, going over the prescribed limits may cause issues. There may be many reasons why a taxpayer goes over the limit, and it may not necessarily be intentional. For example, the CRA may provide the wrong information to a taxpayer regarding their limits on the previous return, therefore leading them to overcontribute. There are two types of overcontributions: a taxpayer may have to pay a tax of 1% per month on excess contributions exceeding the limit, or in a situation where the CRA determines that there is a, “deliberate overcontribution”, typically related to a TFSA (i.e. a contribution made with a view to generate a rate of return sufficient to outweigh the cost of the 1% TFSA overcontribution tax, the excess gains may be characterized as an “advantage” by the CRA and an advantage tax of 100% may have to be paid pursuant to subsection 207.06(1) of the ITA).¹⁸

In the case of an “advantage” tax being applied, the taxpayer may have to file a formal Notice of Objection to the reassessment through a Form T400A.¹⁹If instead the issue concerns the 1% overcontribution tax, the taxpayer can write to the CRA to request a waiver of the penalty and interest through the Form T3012A in the case of an RRSP overcontribution. ²⁰In instances of TFSA overcontributions, although the only remedy is to remove the excess amount from the TFSA (i.e. and obtain proof of the removal), fill out and submit to the overcontribution schedule RC4288²¹along with a cheque for the penalty tax, if the process if followed by a letter explaining the reasonable error, the Minister may exercise their discretion and refund the penalty amount. Typically, the taxpayer will have to explain why the error was made, why it was reasonable to make the error, and describe the steps they took to remedy the excess contribution.

Taxpayers usually should be notified via a warning letter that they have overcontributed, as is CRA’s policy in respect to such overcontributions. Typically, the CRA will invite the taxpayer within a grace period (i.e. 60 days) to withdraw the excess contribution and request the waiver. In a situation where the CRA has made an error, the warning letter is an opportunity to communicate with the CRA and clarify the situation without having to file a formal objection. If no such warning letter was received, it is possible the taxpayer may be successful in arguing that the error was reasonable, and that relief ought to be granted on the overcontribution issue. In a situation where the CRA has misquoted the information to the taxpayer, it would be reasonable to request that they remove the penalty and interest. There are many instances where the CRA MyAccount portal which lists a taxpayer’s contribution room does not update, or updates incorrectly, whereby due to an input or publishing error on the part of the CRA or another arm’s length third-party, such as a banking or financial institution. In such cases a formal objection may not be necessary.²²

Informal Discussions: Requests for disclosure and the game of hot and cold

There may also be situations in which, if the taxpayer has a direct point of contact at the CRA, a discussion with the CRA may coax the agency to fix its own errors. This approach, however, has its risks as do all oral communications with the CRA, as it may cause the CRA to generate a lead for an audit if the taxpayer inadvertently hints at other related or unrelated non-compliance. The reality is that ad hoc solutions to CRA errors cannot have prescribed parameters and are very much rooted to the given situation. At the same time, trying to determine where the CRA erred can be a game of hot and cold. The more likely it is for the CRA’s error to be discovered, the more likely the given department may be in fixing the matter internally. The taxpayer must make it as hot as possible for the CRA and can do that through formal and informal requests for disclosure, and discussions to try to understand where the error originated.

In opaque circumstances, where neither the taxpayer, their accountant or other professionals understand where an error originated, and the CRA or one of its officers have not come forth to admit the error or omission, a discussion with the CRA may be critical. It goes without saying that discussions must be conducted carefully so as to not trigger additional problems. Taxpayers should assume that the conversation is being recorded, even while they are on hold with the CRA. This “conversational” approach is only effective if a given issue has been assigned to, or remains with, either the CRA officer from whom the CRA error originated, or with someone who works in that particular department who may have knowledge of the particular tax mechanism and/or persons who committed the error or omission. There is great variability in the individual skillsets of CRA officers, even if they are assumed to be knowledgeable and competent extensions of the Minister.

Few taxpayers know that they have a right to know the case they must meet before the CRA. As a result, taxpayer may request disclosure of their personal file with the CRA. Although the Access to Information and Privacy Protection Act provides for a formal request process (i.e. ATIP),²³if a taxpayer has a point of contact at the CRA, they may request any and all documentation referenced in the call, and/or materials the CRA is relying on to arrive at their decision. In situations of CRA errors or omissions, a request for disclosure is a signal to the CRA and its officers that it is a matter of time before the error is discovered.

Case Study: Excessive capital dividend election after erroneous CRA CDA verification

For example, it is common for accountants to request the CRA capital dividend account (“CDA”) examiners to verify a corporation’s capital dividend account balance through an analysis of the corporation’s T2 income tax returns, and the incremental year-over-year increases or decreases in the notional CDA balance²⁴This is done in situations when the corporation intends to declare a tax-free capital dividend to its shareholder(s). The CDA verification process is onerous and prone to error, which, if not rectified by the corporation’s accountants or the CRA, may result in an incorrect CDA balance schedule upon which the corporation’s accountants may rely on. In a situation where the CRA officer has produced a higher and incorrect CDA balance schedule, there is a possibility of an excessive election. The consequence of an excessive capital dividend election is a 60% Part III tax assessment.

In a Part III tax assessment situation, most tax practitioners will first assume the error was made by the corporation or their accountant, but in instances where the CRA has made the error, the only way to obtain such confirmation is to discuss the matter with the CRA officer assigned to the issuance of the assessment, make the informal request for disclosure such as the officer’s working papers that led them to produce the erroneous CDA balance schedule, proactively file an ATIP request and inform the CRA officer of the fact, and otherwise instruct them to contact their program officer in Ottawa to explore remedies under the circumstances. In instances where the corporation has identified human error on the part of the CRA in producing a CDA balance schedule and has a direct point of contact with a specific CRA officer, it may be possible to request for an ad hoc solution.

Typically, once the corporation has elected a specific tax treatment, it cannot reverse such an election simply because it resulted in an undesirable or unforeseen tax consequence. In other words, you generally cannot walk back a tax filing after it has already been filed with the CRA. If this was possible, retroactive tax planning would be rampant. In these circumstances where an excessive election was caused by reliance on incorrect information supplied by the CRA, the CRA department may prefer to remedy the error internally. In the alternative, the corporation would either file a TPR application or wait for the Part III assessment only for it to file a formal Notice of Objection which could take many months if not years to resolve.

Such internal remedies may stretch the discretionary spirit of the CRA’s income tax folios,²⁵but nevertheless result in treatment acceptable to the corporation and its shareholder(s). In the case of reliance on an incorrect CDA balance schedule erroneously generated by the CRA, the CRA may be amenable to “absorption”, which would involve the corporation’s notional CDA balance to go below zero, and require it to be topped up with future dispositions of eligible capital property or other transactions, while the shareholder(s) who received the tax-free capital dividend would keep the amount declared to them, tax-free. In other instances, if the amount was never paid out to the shareholder(s) but remains on the books of the corporation in the shareholder loan account, although technically “paid-out” by being “available” to the shareholder(s), there may be an argument there to which the CRA may be amenable to rectify the situation in line with the Supreme Court of Canada’s decision in Canada (Attorney General) v Fairmont Hotels Inc.²⁶by correcting the accounting as an amount owing on the books of the corporation, reversing the excessive election, and avoiding the 60% Part III tax assessment.

Conclusion: Tailoring the remedy to the issue

Unfortunately, there is no easy answer to the panoply of tax problems taxpayers may face if the CRA ought to account for its errors. The likelihood of success if dependent on a variety of variables which range from adequate accounting and legal representation, to human factors such as the CRA’s own officers exercising their delegated discretion as extension of the Minister. Although success is highly dependent on the nature of the error itself, it is possible there may be a little bit of luck involved, as well.

The reality of most tax disputes is that the best and most efficient course of action may not necessarily be the most conventional. Situations exist where a phone call to the right person at CRA can coax the agency to correct its error. In other cases, the formal rigidity of an objection will be essential in obtaining appropriate disclosure from CRA to demolish the Minister’s assumptions and call out the CRA’s errors. For these reasons, it is important to have an experienced tax professional who understands the law, is well practiced, and can apply both conventional and unconventional solutions to your unique tax problem.

References

[1] Income Tax Act, RSC 1985, c 1 (5th Supp) [ITA].

[2] Excise Tax Act, RSC 1985, c E-15 [ETA].

[3] ITA, supra note 1 at subparagraph 152(4)(a)(i).

[4] Ibid, at subsection 152(3.1).

[5] ITA, supra note 1 at subsection 163(2).

[6] Ibid, at subsection 152(4).

[7] Ibid, at subsection 163(2).

[8] Ibid, at subsection 152(4).

[9] T400A, “Notice of Objection – Income Tax Act”, CRA, <https://www.canada.ca/en/revenue-agency/services/forms-publications/forms/t400a.html> [T400A].

[10] GST159, “Notice of Objection (GST/HST)”, CRA, <https://www.canada.ca/en/revenue-agency/services/forms-publications/forms/gst159.html>.

[11] Venne v The Queen, 84 DTC 6247 (FCTD), “… “gross negligence” must be taken to involve greater neglect than simply a failure to use reasonable care. It must involve a high degree of negligence tantamount to intentional acting, an indifference as to whether the law is complied with or not.”

[12] Lacroix v Canada, 2008 FCA 241 (CanLII), <http://canlii.ca/t/22231>, “[26] Although the Minister has the benefit of the assumptions of fact underlying the reassessment, he does not enjoy any similar advantage with regard to proving the facts justifying a reassessment beyond the statutory period, or those facts justifying the assessment of a penalty for the taxpayer’s misconduct in filing his tax return. The Minister is undeniably required to adduce facts justifying these exceptional measures.”

[13]IC07-1R1,“Taxpayer Relief Provisions”, CRA, <https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/ic07-1/taxpayer-relief-provisions-1r1.html#s26>.

[14]RC4288, “Request for Taxpayer Relief – Cancel or Waive Penalties or Interest”, CRA, <https://www.canada.ca/en/revenue-agency/services/forms-publications/forms/rc4288.html> [RC4288].

[15] Federal Courts Act, RSC, 1985, c F-7, at subsection 18.1(1).

[16] ITA, supra note 1.

[17] ETA, supra note 2.

[18] ITA, supra note 1 at subsection 207.06(1).

[19] T400A, supra note 9.

[20] T3012A, “Tax Deduction Waiver on the Refund of your Unused RRSP, PRPP, or SPP Contributions from your RRSP”, CRA, < https://www.canada.ca/en/revenue-agency/services/forms-publications/forms/t3012a.html>.

[21] RC4288, supra note 14.

[22] Income Tax Folio S3-F10-C3, “Advantages – RRSPs, RESPs, RRIFs, RDSPs and TFSAs”, CRA, <https://www.canada.ca/en/revenue-agency/services/tax/technical-information/income-tax/income-tax-folios-index/series-3-property-investments-savings-plans/series-3-property-investments-savings-plan-folio-10-registered-plans-individuals/income-tax-folio-s3-f10-c3-advantages-rrsps-rrifs-tfsas.html>.

[23] Access to Information and Privacy (ATIP) Online Request, Government of Canada, <https://atip-aiprp.apps.gc.ca/atip/welcome.do> [ATIP].

[24] Income Tax Folio S3-F2-C1, “Capital Dividends”, CRA, <https://www.canada.ca/en/revenue-agency/services/tax/technical-information/income-tax/income-tax-folios-index/series-3-property-investments-savings-plans/series-3-property-investments-savings-plan-folio-2-dividends/income-tax-folio-s3-f2-c1-capital-dividends.html> [CDA Folio].

[25] Ibid.

[26] Canada (Attorney General) v Fairmont Hotels Inc., 2016 SCC 56.