Melman, 2017 FCA 83: signing a return unread can be gross negligence under s. 163(2)

2017 FCA 83 · Federal Court of Appeal

Author: Sas Tullo

This is a short bench decision of the Federal Court of Appeal on gross negligence penalties under the Income Tax Act. A taxpayer had left a large amount of taxable dividends out of his 2007 return, the Minister assessed penalties under subsection 163(2), and the Tax Court upheld them. The Court of Appeal dismissed the taxpayer’s further appeal with costs. The case matters to anyone who signs a return prepared by someone else: the Court confirmed that the Crown does not have to prove the taxpayer knew of the omission, and that ignoring clear warning signs can be enough.

Facts

The appellant, Anthony Melman, failed to include certain taxable dividends in his income tax return for the 2007 taxation year. The Minister reassessed to impose gross negligence penalties under subsection 163(2), and the Tax Court of Canada dismissed his appeal in reasons cited as 2016 TCC 167 (para 1).

The Court of Appeal summarized the Tax Court’s findings of fact. The appellant signed his return without reviewing or reading it in draft or final form, departing from his usual practice of meeting his primary accountant in person to review the return page by page; the Tax Court characterized that departure as an unusual casualness and an indifferent delegation of responsibility (para 6). After the dividends were declared and paid, the appellant had arranged an escrowed investment in an amount designed to cover the estimated tax due in April 2008. That investment matured and was redeployed at about the time the 2007 return was filed, without anyone asking why the funds were no longer needed (para 6).

Issues

The appellant argued that the Tax Court erred in three respects: by misapplying the legal test for gross negligence, by finding that the respondent had met her onus of proof, and by failing to weigh properly the totality of the evidence (para 2).

Holding

The appeal was dismissed with costs (para 10). The Tax Court applied the correct legal test (para 4); the Crown was not required to prove actual knowledge, because subsection 163(2) is disjunctive (para 5); the findings of fact disclosed no palpable and overriding error and supported a finding of wilful blindness amounting to gross negligence (paras 7 and 9); and the Tax Court correctly stated and applied the onus (para 8).

The court’s reasoning

Dawson J.A., for a panel that also included Webb and Rennie JJ.A., delivered the reasons from the bench. The analysis began with the text of subsection 163(2) of the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.), which imposes a penalty on a taxpayer who, knowingly or under circumstances amounting to gross negligence, makes, participates in, assents to, or acquiesces in the making of a false statement or omission in a return (para 4). The Court held that the Tax Court, at paragraphs 29 to 30 of its reasons, had articulated the correct test: gross negligence is “neglect beyond a failure to use reasonable care” and requires a high degree of negligence equal to intentional acting or indifference as to compliance, citing Venne v. Her Majesty the Queen, [1984] C.T.C. 223, 84 D.T.C. 6247, at paragraph 37 (para 4).

The Court then rejected the submission that the Crown had to establish that the appellant knowingly made the omission. Subsection 163(2) is disjunctive: an omission made in circumstances amounting to gross negligence suffices without proof of knowledge (para 5).

On the facts, the Court applied the appellate standard of palpable and overriding error to the Tax Court’s findings. It identified two findings as decisive. The first was the unread return, signed in a departure from the appellant’s usual practice, which the Tax Court had said “constituted an unusual casualness” (para 6, citing paras 40 and 43 of the Tax Court’s reasons). The second was the escrowed investment set aside to pay the anticipated tax, which matured and was redeployed when the return was filed; the Tax Court treated the maturity of a large, matching, purpose-specific investment as a clear reminder to inquire why the funds were no longer needed (para 6, citing paras 11 and 45 of the Tax Court’s reasons). No palpable and overriding error had been shown in those findings, and they supported the conclusion of wilful blindness amounting to gross negligence (para 7).

On onus, the Court noted that the Tax Court had required the Crown to prove that the appellant “was, more likely than not, wilfully blind to the warnings or markers set before him” that would have led to detection of the omission (para 8). Given that statement of the law and the findings made, the appellant had not shown any error in the conclusion that the onus was met (para 8). Finally, because the gross negligence inquiry is highly fact-specific, and no palpable and overriding error had been demonstrated in the Tax Court’s appreciation of the evidence as a whole, the third ground also failed (para 9).

Practical implications

The decision adds little new doctrine, but it is a clear appellate endorsement of three propositions that recur in penalty litigation. First, the Venne formulation remains the governing test for gross negligence under subsection 163(2). Second, the subsection’s two branches are alternatives, so the Minister need not prove that the taxpayer actually knew of the false statement or omission. Third, wilful blindness is a route to gross negligence, and the question whether a taxpayer was wilfully blind is one of fact reviewed only for palpable and overriding error.

In my view, the practical lesson lies in the two facts the Court singled out. Signing a return unread is not, by itself, decisive; what mattered was that the appellant abandoned his own established review practice, and that he had a specific reminder of the liability in the form of a tax reserve that was quietly released. Where a sophisticated taxpayer sets up a mechanism to meet a known tax liability and then does nothing when that mechanism is unwound at filing time, a court will readily find that warning markers were ignored. Advisers who prepare returns for clients with significant one-off income should document that the client was told of the item and had the opportunity to review the return, since the client’s own conduct, not the preparer’s, is what the penalty analysis examines.

The case also illustrates the limits of an appeal from a penalty finding. Once the Tax Court has stated the Venne test and the correct onus, the remaining questions are factual, and the Court of Appeal will not reweigh the evidence. Whether an appeal was taken to the Supreme Court of Canada is not verified here.

A taxpayer who signs a return without reading it takes the risk that the return is wrong, and if there were signs of the error that a reasonable person would have followed up, a gross negligence penalty can follow. The Crown does not have to prove the taxpayer knew. Readers should watch for how later Tax Court decisions treat the “warning markers” idea when the taxpayer is less sophisticated than Mr. Melman was.

This comment is general information, not legal advice. The law may have changed since the decision; check the current text in the tax wiki.

Citation and links

Melman v. Canada, 2017 FCA 83, judgment delivered from the bench at Toronto on April 25, 2017. Panel: Dawson, Webb, and Rennie JJ.A.; reasons of the Court by Dawson J.A. Appeal from Melman v. The Queen, 2016 TCC 167. Reasons on the Federal Court of Appeal’s site. Also on CanLII.