Third-Party Civil Penalties for Accountants: What they are, what you need to know about them, and what you can do to avoid them.
(This article first appeared in Thomson Reuters’ Tax Advocate publication.)
Introduction
The Department of Finance’s planned changes to the taxation of private corporations will make tax compliance even more onerous, complicated, and fraught with potential errors. Many accountants tell us they fear potential future exposure to third-party civil penalties (TPPs). TPPs are levied under § 163.2 of the Income Tax Act (ITA)[1] and § 285.1 of the Excise Tax Act (ETA).[2]
It is no wonder that accountants are concerned. The Canada Revenue Agency (CRA) reports and the results of an access to information request show that the quantum of penalties that CRA is assessing is high and on the rise. In addition, the breadth of consequences stemming from such assessments is becoming more and more apparent. Meanwhile, the lack of case law dealing with TPPs and the uniqueness of the “culpable conduct” standard makes it difficult for accountants to know exactly what is required of them to meet their obligations and avoid such an assessment.
Given the soon-to-be up-tick in tax compliance complexity and the high stakes of errors, accountants must be fully informed on the law surrounding TPPs. In this article, we provide data on CRA’s assessment of TPPs; canvas the consequences of a TPP assessment; provide an in-depth analysis of the penalty provisions, their history, and the culpable conduct standard; and review practical steps that accountants should take to avoid such an assessment.
CRA is assessing a high volume of TPPs
The quantum of TPPs that CRA is assessing is significant and escalating over time. On August 31, 2017, the Minister of National Revenue (the “Minister”) reported to the House of Commons Standing Committee on Finance that, during its 2017 fiscal year, CRA assessed a total of $44 million in TPPs on promoters and tax preparers.[3] This represents a significant increase over previous years. The results of our access to information request revealed that the total penalties resulting from TPP audits during the six years prior to 2017 averaged only $27 million per year.
If you are assessed, the consequences are grave
a) Fighting is costly
Disputing a TPP is time consuming and costly. These disputes can take in the range of five years to be resolved. In the meantime, the accountant is left in financial limbo in how they plan their affairs. Irrespective of the outcome, defending against TPPs result in legal expenses. Furthermore, the magnitude of stress that the accountant experiences throughout the process is enormous.
b) Lose the PR battle
The reality for many accountants is that, even if they did want to dispute a TPP assessment, they could not because of the negative public relations ramifications that would come from such a dispute. The results of our access to information request supports this theory. CRA reported that between April 1, 2010 and May 19, 2017 only five TPP appeals were filed with the courts. We have also heard stories of accounting firms swallowing TPP assessments that they believe are unjustified in order to avoid any publicity. Notices of appeal filed with the TCC are public documents. The risk that an accountant’s clients might learn of the accusation may be too high.
c) Loss of E-filing
In addition, preparers may lose their Efiling privileges just for being assessed a TPP. Under the ITA, only those persons who meet the CRA’s specified criteria may file returns electronically.[4] One such criterion is for the person to “not have been assessed a penalty under the Income Tax Act.”[5] While the ITA prevents the Minister from taking collections action against a taxpayer who owes income tax while the taxpayer disputes the assessment, there is no such restraint on the CRA retracting an accountant’s Efiling privileges during the time in which the dispute is being resolved. Given the importance of Efiling to the business operations of modern accountants, simply being assessed a TPP can compromise an accountant’s livelihood, even if the assessment is ultimately vacated.
d) Amount is potentially infinite
Ostensibly there is a cap to TPP penalties. For the planner penalty, defined below, the cap is the planner’s total compensation from their impugned activity.[6] For the preparer penalty, also defined below, the cap is the preparer’s total compensation plus $100,000.[7] As they are, these penalties can run into the hundreds of thousands of dollars. However, the penalties can, in practice, be infinite because the reliance on the false statement is assessed on an individual, person-by-person basis (i.e., every time another person relies on the false statement, another penalty is levied). As the TCC has observed, this makes TPPs potentially more fiscally punitive than the criminal tax evasion fines under § 239 of the ITA.[8]
Overview of the legislative intent and provision
In the following section, we review the original motivation behind TPPs and their most salient features.
a) Origins and legislative intent
TPPs were introduced in the 1999 Federal Budget and went into force in June 2000. They were enacted with accountants and tax advisors specifically in mind.[9] Parliament was responding to cases such as Global Communications v R,[10] in which the tax advisors of a major law firm knowingly over-estimated the fair market value of the taxpayer’s purchase and then relied on that over-estimation to claim certain deductions on the taxpayer’s behalf. Although many of the expenses were ultimately denied, Parliament was concerned by the central role played by the tax advisors in such a scheme and its inability to effectively prohibit these practices. Outside of trying to level criminal charges on the tax advisors, which would impose a significant evidentiary burden on the Crown, there was nothing the Crown could do. At the time, civil penalties applied only to taxpayers misrepresenting their own tax returns.[11] As Brian R. Carr and Grace Pereira note, Parliament also wanted to deter unscrupulous tax preparers from building “practices by advising clients to claim deductions to which they were not entitled.” [12]
Therefore, the objective of TPPs, as the CRA’s Information Circular IC01-1 “Third-Party Civil Penalties” (“IC01-1”) explains, “is to deter third parties from making false statements or omissions in relation to income tax or goods and services tax”:
Specifically, [the legislation] is meant to apply to those persons who counsel and assist others in making false statements when they file their returns or who are willfully blind to obvious “errors” when preparing, filling, or assisting another person in filing a return. It is also intended to apply to arrangements and plans that contain false statements, often without the knowledge of the client.[13]
b) Two types of penalties
There are two types of TPPs: the so-called “planner penalty” and the so-called “preparer penalty.” The planner penalty, under § 163.2(2), targets individuals planning and promoting tax shelters, as well as those providing appraisals or valuations of them.[14] The preparer penalty, under § 163.2(4), targets those preparing tax returns or providing tax advice.[15]
Penalty for misrepresentations in tax planning arrangements
163.2 (2) Every person who makes or furnishes, participates in the making of or causes another person to make or furnish a statement that the person knows, or would reasonably be expected to know but for circumstances amounting to culpable conduct, is a false statement that could be used by another person (in subsections (6) and (15) referred to as the “other person”) for a purpose of this Act is liable to a penalty in respect of the false statement.
Penalty for participating in a misrepresentation
163.2 (4) Every person who makes, or participates in, assents to or acquiesces in the making of, a statement to, or by or on behalf of, another person (in this subsection, subsections (5) and (6), paragraph (12)(c) and subsection (15) referred to as the “other person”) that the person knows, or would reasonably be expected to know but for circumstances amounting to culpable conduct, is a false statement that could be used by or on behalf of the other person for a purpose of this Act is liable to a penalty in respect of the false statement.[16]
The key distinction between the two penalties is that the § 163.2(4) preparer penalty applies where the false statement is made or assented “to, or, by or on behalf of, another person.” Hence, for § 163.2(4) to apply, the person making use of the false statement must be identified. No actual person needs to be identified for § 163.2(2) to apply.[17] Outside of this distinction, a false statement or culpable conduct can give rise to either penalty.[18] For both penalties, the burden is on the Minister to establish third-party liability on the balance of probabilities.[19]
c) Limited case law
To date, only two TPP appeals have proceeded to trial: Guindon v R,[20] a case that fell out of a tax scheme and went all the way to the Supreme Court of Canada (SCC), and Ploughman v R,[21] which stemmed from the same scheme. In Guindon, a lawyer endorsed a timeshare donation program without reviewing the legal documents. She then had the charity she was a director of issue false donation receipts for the timeshares that were never donated. In Ploughman, a tax advisor advised those same donors to submit their receipts to the CRA, even though the timeshares had not yet been created. In both cases, the appellants were found liable.[22]
d) False statement
“False statement” includes “a statement that is misleading because of an omission from the statement.”[23] No further definition of the term is provided anywhere in the ITA or the ETA. Historically, the courts have interpreted “false statement” to mean “an assertion with respect to a matter of fact, opinion, belief or knowledge, knowing that the assertion is false.”[24] To prove a statement is false, the Crown had to prove that the person making the statement knew it was false and made it for fraudulent purposes.[25] CRA’s position, however, is that a person making, participating, or assenting to the false statement need not have “any intention to deceive.”[26] Due to the paucity of reported TPP cases, it is uncertain whether this position would hold up in court.
The CRA indicates that false statements that resulted from “honest error” will be exempt.[27] Besides providing an example of a basic input error (writing $10,098 instead of $1,098 on a T1)[28], the CRA does not further clarify what constitutes an “honest error.” Is a misunderstanding of a new law or test an “honest error”?
e) Culpable conduct
TPP assessments will usually turn on the question of “culpable conduct.” The term is defined under § 163.2(1) as
conduct, whether an act or failure to act, that
(a) Is tantamount to intentional conduct;
(b) Shows an indifference as to whether this Act is complied with; or
(c) Shows a willful, reckless or wanton disregard of the law.
This definition is very similar to how gross negligence is typically defined. Indeed, TPPs were originally intended to be subject to the gross negligence standard found in § 163(2). Parliament however ultimately substituted “culpable conduct” for “gross negligence in response to concerns by tax professional that under “gross negligence” they may be liable even for an honest error of judgement or an honest difference of opinion.[29] Nevertheless, as the IC01-1 notes, Parliament defined “culpable conduct” with references to the same criteria courts consider in determining gross negligence under § 163(2). [30]
The reliance on the criterion of gross negligence to establish culpable conduct raises critical questions: Is culpable conduct the same as gross negligence? If so, what would distinguish gross negligence and culpable conduct from ordinary negligence in the context of actions taken by an accountant? To a large extent these questions remain unresolved.
In Guindon, the SCC confirmed that the standard of culpable conduct “must be at least as high as gross negligence under § 163(2) of the ITA.”[31] The Court noted that “willful, reckless or wanton disregard of the law” is a term borrowed from criminal law and implies a degree of mens rea, while “tantamount to intentional conduct” and “indifference” are established gross negligence concepts.[32] Given that the provision uses “or,” behaviour that meets the gross negligence concepts is sufficient to warrant a TPP assessment.
This is troubling because courts rarely draw a distinction between ordinary negligence (absence of reasonable care) and gross negligence (indifference to the law, or negligence tantamount to intentional acting). Typically, a finding of simple negligence is only made where the person has limited education or language skills.[33] It is extremely unlikely that judges would consider accountants and tax advisors as having a limited education—as one Charted Professional Accountant (CPA) recently found out when he unsuccessfully tried to argue that his lack of education contributed to his making a false statement in his tax return.[34] For these reasons, any false statement that an accountant makes as a result of mere negligence that could lead to their client making a false statement on their tax return exposes the accountant to liability to TPPs.
f) Employers liable for employees’ false statements and culpable conduct
Subsection 163.2(15) specifies that an employer will be held directly liable, under § 163(2), if they make use of a false statement made or acquiesced to by their employee. In other words, CRA will not assess the employee for making a false statement; they will assess their employer.
g) Limited good faith protection
Subsection 163.2(6) states that an advisor who acts on behalf of the person who relies on the false statement will not be liable for TPPs solely because the advisor relied, in good faith, on information provided by, or on behalf of, the other person. The advisor is also protected if because of a good faith reliance they failed to verify, investigate or correct the information.
This protection does not apply when the advisor relies on information provided by another third-party, such as a fellow tax advisor. The information must come directly from the person, or their representative, who will make use of the false statement in their personal tax matter.
Moreover, as the TCC recently affirmed in Ploughman, for the good faith reliance to be valid the advisor must be “free from the knowledge of circumstances which ought to put the holder on inquiry.”[35] What “ought to put the holder on inquiry” is an objective question. That is, is there anything in the provided information that could cause “a reasonable and prudent person to believe that the information could be incorrect?”[36]
Accountants, therefore, cannot blindly rely on their clients’ assurances. If there are reasons to suspect what their clients tell them, they are expected to take steps to verify those statements. Otherwise, they may be held liable for acquiescing or assenting to a false statement.
Similarly, accountants must remain alert even when compiling financial statements. According to § 9200(.17) of the CICA Handbook, a public accountant in a compilation engagement “is not required to make inquiries or perform other procedures to verify, corroborate or review information to him or her.” As Keith Trussler, points out, this is a far lower standard than the ITA imposes. Consequently, it is possible that an accountant might comply with the obligations described in the Handbook and still be in breach of § 163.2.[37]
h) No statute of limitation
There is no statutory time limit on assessing TPPs. All false statements and culpable conduct after June 29, 2000 can be assessed,[38] and as Guindon and Ploughman illustrate, it can be several years before the CRA decides to pursue TPPs.
How to avoid TPPs.
Here are some practical actions accountants and tax advisors should take in order avoid a TPP assessment. While these recommendations are not new, adhering to them scrupulously is becoming even more important as tax compliance becomes more complicated and CRA increases its assessments of TPPs.
a) Take detailed notes. Keep a record of everything your clients tell you and everything they ask you. Some advisors tell us they fear that, in the absence of solicitor-client privileges for accountants, extensive notes may unduly expose their clients to risk. But accountants are obliged and entitled to keep a written record of their work, despite any risk that imposes on their client. This record is critical for advisors to protect themselves from accusations of impropriety, particularly since penalties are often assessed years after the alleged misconduct.
b) Investigate suspicious claims. Take active measures to verify your clients’ statements. As Bruce Ball, Vice-President of Taxation at CPA Canada, points out, this does not mean accountants have to audit every statement, but they should “consider whether the information makes sense based on their knowledge of the client.” If a client claims an expense that they have not before, ask for details and records of that expense and keep a record of your inquiries.
c) Establish checks and balances. Bad judgment is often the result of bad planning. Establishing and following rigorous internal quality control procedures can help detect errors that would otherwise go unnoticed. Although the specific procedures will vary, a robust quality control system should include oversight at the leadership level, clear client acceptance and continuance guidelines, long-term data retention measures, and independent monitoring.[39] While the initial cost of implementing such mechanisms may seem high, the potential future cost of undetected errors can be disastrous.
d) Bill the client for your investigation time. If clients do not have the documentation readily available to support their claims with regards to their filings, that is their shortcoming, not yours. By confirming the legitimacy of their claims before they file their tax returns, you are providing a service to the client. As such, the client should bear the cost of you providing that service. Billing the client ensures you are not disincentivized from protecting your client and yourself.
e) Maintain independence. Preserving independence is particularly critical for those professionals who service a few select clients. No client can ever compensate you for your loss of reputation, irrespective of the portion of your business that they represent.
Conclusion
TPP assessments are likely to increase in the coming years, as the tax system grow more and more complex. At the same time, TPPs remain largely unknown and untried. Although they may be intended to penalize the most egregious forms of misrepresentations and negligence, their impact is potentially far broader. They can be applied years into the past, result in exorbitant penalties, and unduly punish inadvertent misconduct. Merely being assessed a TPP can jeopardize one’s career. Given the high stakes of Third Party Penalties, it is critical that accountants understand the nuances of the provisions, stay abreast of developments in this area of the law and take proactive steps to protect themselves.
Disclaimer
This article is for informational purposes only and does not constitute legal advice. If you wish to discuss your issue with a lawyer, contact us today at (613) 702-0322 or info@blachfordtaxlaw.com
[1] RSC 1985, c 1 (5th Supp).
[2] RSC 1985, c E-15. The ITA and ETA provisions are nearly identical. In this article we focus on the ITA provision, but our comments apply equally to the ETA.
[3] Minister of National Revenue, “Report on progress: commitments made in the government’s response to the sixth report of the standing committee on finance” (31 August 2017) at http://www.ourcommons.ca/content/Committee/421/FINA/WebDoc/WD9074771/421_FINA_reldoc_PDF/CanadaRevenueAgency_2017_08_31-e.pdf. See also CRA, “Cracking down on tax evasion and aggressive tax avoidance and getting results” (3 November 2017) at https://www.canada.ca/en/revenue-agency/campaigns/about-canada-revenue-agency-cra/cracking-down-on-offshore-tax-evasion-aggressive-tax-avoidance/cracking-down-getting-results.html.
[4] § 150.1(2). See also Paterson v Canada, 2010 FC 644, aff’d 2011 FCA 12.
[5] Government of Canada, “Eligibility” at https://www.canada.ca/en/revenue-agency/services/e-services/e-services-businesses/efile-electronic-filers/eligibility.html.
[6] § 163.2(3); § 285.1(3) in the ETA.
[7] § 163.2(5); § 285.1(5) in the ETA.
[8] Guindon v R, 2012 TCC 287 at para 70 [Guindon TCC].
[9] For a comprehensive account of the history of § 163.2, see Brian R. Car & Grace Pereira, “The Defence Against Civil Penalties” (2000) 46:6 Can Tax J 1737 at 1742-1744 [Carr & Pereira]. Our summary is indebted to their article.
[10] 1999 CarswellNat 1027, 99 DTC 5377 (FCA), aff’g 1997 CarswellNat 758, 97DTC 1293 (TCC).
[11] Vern Krishna, Income Tax Law, Second Edition (Toronto: Irwin Law, 2009) at 556.
[12] Supra note 10 at 1744.
[13] IC 01-1 at paras 3, 15.
[14] § 285.1(2) in the ETA.
[15] § 285.1(4) in the ETA.
[16] ITA, supra note 1.
[17] IC 01-1 at para 7. The distinction discussed above is also found between § 285.1(2) and § 285.1(4) of the ETA.
[18] § 163.2(14).
[19] IC 01-1 at para 60. The Minister also has the burden of proving the ETA penalties on the balance of probabilities.
[20] Guindon TCC, supra note 9, rev’d in part 2013 FCA 153, rev’d in part 2015 SCC 41 [Guindon SCC].
[21] 2017 TCC 64 [Ploughman].
[22] In Guindon, the TCC ruled that Guindon was culpable under § 163.2, but ultimately vacated the assessment because it found § 163.2 to be effectively a criminal provisions and thus beyond the scope of the ITA. On appeal, both the FCA and the SCC ruled that § 163.2 is an administrative penalty and reinstated the assessment.
[23] § 163.2(1) “false statement.”
[24] Ste-Marie v MNR, 1964 CarswellNat 193 at 42, 36 Tax ABC 129 (TAB).
[25] Ibid at 45.
[26] IC 01-1 at para 22.
[27] Ibid.
[28] Ibid at 12 (“Example 3: Honest Error”).
[29] Guindon TCC, supra note 9 at para 35.
[30] IC 01-1 at para 24.
[31] Supra note 21 at para 61.
[32] Ibid at paras 58-59.
[33] For examples see R v Venne, [1984] CTC 223 (FCTD) (taxpayer not grossly negligent because only has 5th grade education and speaks very little English); Rui De Couto c/o Alco Windows Inc v R, 2013 TCC 198 (taxpayer not grossly negligent because has limited language facility and education); Lavoie v R, 2015 TCC 228 (taxpayer not grossly negligent because only has 6th grade education); and Liu v R, 2017 TCC 117 (taxpayer not grossly negligent because has below-average knowledge of tax system).
[34] Rowe v R, 2017 TCC 122 at para 19.
[35] Ploughman, supra 22 at para 68.
[36] IC 01-1 at para 35.
[37] Keith Trussler, “Third Party Civil Penalties: Aggressive Filing, False Statement or Just Doing Your Job?” The Charted Accountant Risk Management Newsletter 15:3 (December 2006) 1, at 2.
[38] IC 01-1 at para 13.
[39] CPA Canada sells a Quality Assurance Manual, complete with template policies and sample procedures, that can be tailored to a firm’s individual needs. See: https://www.cpacanada.ca/en/business-and-accounting-resources/audit-and-assurance/standards-other-than-cas/publications/quality-assurance-manual