Penalty Test

"In confirming the reassessment of the statute-barred years and the assessment of the penalties under subsection 163(2) of the Act in this case, the Tax Court Judge noted, in the paragraph immediately following the excerpt quoted in these reasons at paragraph 16 above:\n\nBased on Lacroix, once the Minister has established with reliable evidence a substantial discrepancy with reported income, which has not been credibly explained, the taxpayer must then identify the source of the income and show that is not taxable. In my view, the Appellant did not do so in this case for the reasons previously discussed.\n\n[emphasis added]\n\nHowever, if Mr. Deyab would have “[identified] the source of the income and [shown] that it was not taxable”, then the amounts would not have been included in his income at all. Not only would there not be any penalties, there would be no tax payable. Simply finding that an unreported amount is taxable does not inevitably lead to a conclusion that a gross negligence penalty is justified. The Tax Court Judge effectively equated the test for determining whether a gross negligence penalty should be assessed with the test for determining whether the amounts were taxable. In my view, the Tax Court Judge erred in doing so.\n\nThe right to reassess a statute-barred year and the right to assess a gross negligence penalty are both premised on a taxpayer having unreported income for a particular taxation year. Once it has been established that a taxpayer had unreported income, the circumstances related to the failure to report the income must be examined to determine if such failure was attributable to neglect, carelessness, wilful default or fraud (to reassess a statute-barred year) or gross negligence (to justify the assessment of the gross negligence penalty).\n\nIt appears that the Tax Court Judge was basing his reading of Lacroix on the following statement by this Court in paragraph 32 of Lacroix:\n\n[…] Insofar as the Tax Court of Canada is satisfied that the taxpayer earned unreported income and did not provide a credible explanation for the discrepancy between his or her reported income and his or her net worth, the Minister has discharged the burden of proof on him within the meaning of subparagraph 152(4)(a)(i) and subsection 162(3) [sic].\n\nHowever, these comments must be read in light of the case that was before this Court in Lacroix. In paragraph 30, this Court noted:\n\n[30] The facts in evidence in this case are such that the taxpayer's tax return made a misrepresentation of facts, and the only explanation offered by the taxpayer was found not to be credible. Clearly, there must be some other explanation for this income. It must therefore be concluded that the taxpayer had an unreported source of income, was aware of this source and refused to disclose it, since the explanation he gave was found not to be credible. In those circumstances, the conclusion that the false tax return was filed knowingly, or under circumstances amounting to gross negligence, is inescapable. This justifies not only a penalty, but also a reassessment beyond the statutory period.\n\nIn the circumstances of Lacroix, the failure to provide a credible explanation was sufficient to justify the assessment of the gross negligence penalty and the reassessment of the statute-barred years. The comments of this Court in Lacroix do not support the conclusion that, in order to set aside a gross negligence penalty, “the taxpayer must […] identify the source of the income and show that is not taxable”."