Tax Court Provides Clarity on Harsh Provision

Judges are forced to apply the law as it reads, but fortunately for taxpayers there is sometimes room for interpretation.

As the Honourable Justice David E. Graham stated in Galachiuk v. The Queen, subsection 163(1) of the Income Tax Act (the Act) is a “harsh provision”.

Subsection 163(1) of the Act provides:

• Every person who

(a) fails to report an amount required to be included in computing the person’s income in a return filed under section 150 for a taxation year, and

(b) had failed to report an amount required to be so included in any return filed under section 150 for any of the three preceding taxation years

is liable to a penalty equal to 10% of the amount described in paragraph 163(1)(a), except where the person is liable to a penalty under subsection 163(2) in respect of that amount.

In Galachiuk v. The Queen, Mr. Galachiuk failed to report $683 in investment income for his 2008 taxation year. In 2009 he failed to report $436,890 in income relating to a pension payment. Since subsection 163(1) imposes a 10% penalty on the amount of the unreported income, not the amount of tax that has not been paid, the penalty would have been a hefty one for Mr. Galachiuk.

An important issue of the case was whether Mr. Galachiuk could rely on the due diligence defence for either the 2008 or 2009 taxation years, or whether he would only be able to rely on the defence for the 2009 taxation year. This issue has only ever been considered in informal procedure cases.

Justice Graham pointed out that at least two judges have held that an appellant must show that they were duly diligent in filing their tax return in the year in respect of which the Minister applied the penalty, but that at least three other judges have held that an appellant need only show that they were duly diligent in one of the two tax years.

Fortunately for Mr. Galachiuk, and other taxpayers facing the harsh provision in the future, Justice Graham preferred the latter approach. The reason being that since the penalty can only be imposed if a taxpayer fails to include an amount in income in two different years, there is one prohibited act consisting of two failures – one is the failure to include an amount in income in one year, and the second is the failure to include an amount in income in another year that is within three years following the first failure.

At paragraph 8 Justice Graham stated:

“Given the harsh and potentially disproportionate results of this penalty, if Parliament wanted to limit the circumstances in which a due diligence defence would be available, I believe that it would have expressly stated so in the subsection. Absent such an express limitation, it is my view that a due diligence defence is available to explain the omission in either year.”

In the end, Mr. Galachiuk was able to avail himself of the subsection 163(1) penalty because it was found that he was duly diligent with regard to his 2008 taxation year. This interpretation of subsection 163(1) is an important, precedent setting decision of the Tax Court that will beneficially affect taxpayers in the future.

Greer Jacks is updating jurisprudence in EverGreen Explanatory Notes, an online research library of assistance to tax and financial professionals in working with their clients.