CRA Gross Negligence Penalties in Canada: Lessons From Khanna v. Canada

Gross negligence penalties can significantly increase the cost of a CRA reassessment. However, the existence of unreported income, an incorrect deduction, or another tax error does not automatically justify a gross negligence penalty.

The Federal Court of Appeal decision in Khanna v. Canada, 2022 FCA 84 provides an important example of the evidence the Crown must establish before a taxpayer can be held liable for a penalty under subsection 163(2) of the Income Tax Act.

This article explains how CRA gross negligence penalties work, who bears the burden of proof, and what the Khanna decision means for taxpayers challenging these penalties.

What Is a CRA Gross Negligence Penalty?

Subsection 163(2) of the Income Tax Act can impose a penalty where a taxpayer knowingly, or under circumstances amounting to gross negligence, makes or participates in a false statement or omission in a tax return or other specified filing.

Gross negligence requires more than an ordinary mistake or a simple failure to exercise reasonable care.

Canadian courts have described gross negligence as conduct involving a high degree of negligence approaching intentional conduct or indifference as to whether the law is complied with.

How Much Is the Gross Negligence Penalty?

For income tax purposes, the penalty under subsection 163(2) is generally the greater of:

• $100; or
• 50% of the amount determined under the statutory penalty formula relating to the false statement or omission.

In many cases involving understated income or improperly claimed deductions, the practical result can be a penalty equal to approximately 50% of the additional tax attributable to the misrepresentation.

GST/HST has a separate gross negligence penalty regime under section 285 of the Excise Tax Act, generally based on 25% of the relevant understated net tax, tax payable, or overstated rebate, subject to the statutory formula.

Does Every Tax Error Amount to Gross Negligence?

No.

A tax return can be incorrect without the taxpayer being grossly negligent.

There is an important distinction between:

• An innocent mistake;
• Ordinary negligence;
• Carelessness;
• Wilful blindness;
• Knowing misrepresentation; and
• Gross negligence.

The CRA must establish the facts necessary to justify the penalty rather than relying solely on the fact that additional tax is owing.

Who Has the Burden of Proof for Gross Negligence Penalties?

Subsection 163(3) of the Income Tax Act provides that, where a penalty under section 163 is disputed in an appeal, the burden of establishing the facts justifying the penalty is on the Minister.

This is important because the evidentiary burden for a penalty differs from the ordinary assumptions that may apply to the underlying tax assessment.

The Crown generally must establish, on a balance of probabilities, that:

• There was a false statement or omission; and
• The taxpayer made, participated in, assented to, or acquiesced in that misrepresentation knowingly or under circumstances amounting to gross negligence.

What Happened in Khanna v. Canada?

Khanna v. Canada, 2022 FCA 84 arose from CRA reassessments involving Mr. and Ms. Khanna.

They worked as mortgage brokers through a corporation they jointly owned and were reassessed following a CRA net worth audit.

The CRA reassessed unreported income for the 2008 taxation year and imposed gross negligence penalties under subsection 163(2) of the Income Tax Act.

At the Tax Court hearing, the taxpayers conceded the unreported income amounts. The remaining issue was whether the gross negligence penalties were legally justified.

What Did the Tax Court Decide?

The Tax Court initially upheld the penalties.

Among other things, the Tax Court relied on findings concerning the amount of unreported income, the taxpayers’ professional backgrounds, their financial circumstances, and their conduct during the CRA audit.

Both taxpayers appealed to the Federal Court of Appeal, although Mr. Khanna did not pursue substantive arguments on appeal. The central issue therefore became whether the penalties imposed on Ms. Khanna could be sustained.

What Did the Federal Court of Appeal Decide?

The Federal Court of Appeal allowed Ms. Khanna’s appeal and concluded that the Crown had not established the facts necessary to justify the gross negligence penalties against her.

The Court found that much of the evidence and many of the factual findings related to her husband rather than to Ms. Khanna personally.

The Court emphasized that the Crown still had to prove that Ms. Khanna herself made the misrepresentation knowingly or in circumstances amounting to gross negligence.

Why Was the Evidence Insufficient?

The Federal Court of Appeal identified several evidentiary problems.

Among other things:

• There was no sufficient evidence establishing Ms. Khanna’s knowledge of the unreported income when the return was filed;
• There was no adequate basis for attributing her husband’s conduct during the later CRA audit to her state of mind when the tax return was prepared;
• The record did not establish that she deliberately ignored information showing that the return was incorrect; and
• The mere existence of substantial unreported income did not establish gross negligence.

As a result, the Federal Court of Appeal directed that the penalties imposed on Ms. Khanna be removed.

Does Unreported Income Automatically Prove Gross Negligence?

No.

This is one of the most important lessons from Khanna.

A taxpayer may ultimately accept that income was not reported while still disputing whether the circumstances justify a gross negligence penalty.

The underlying tax assessment and the penalty are separate issues.

For more information about omitted income, see our Failure to Report Income in Canada guide.

What Is Wilful Blindness?

Wilful blindness can sometimes support a finding of gross negligence.

However, wilful blindness is more than simply failing to notice an error.

It generally involves a deliberate decision not to make inquiries because the taxpayer does not want to learn the truth.

In Khanna, the Federal Court of Appeal found that the evidence did not establish that Ms. Khanna deliberately chose not to make inquiries or deliberately ignored an inconvenient truth.

Can the CRA Rely on Your Spouse’s Conduct?

The facts concerning a spouse or business partner may sometimes be relevant, but gross negligence must ultimately be established against the taxpayer who has been assessed the penalty.

Khanna demonstrates why the CRA and the Crown cannot simply assume that the conduct or knowledge of one spouse automatically establishes gross negligence by the other spouse.

The evidence must support the penalty against the particular taxpayer.

Does Using an Accountant Protect You From Gross Negligence Penalties?

Not automatically.

Hiring an accountant or tax preparer does not by itself eliminate a taxpayer’s responsibility for a return.

At the same time, the involvement of a professional can be relevant to the factual analysis.

Important questions may include:

• What information did the taxpayer provide to the preparer?
• Did the taxpayer review the return?
• Were obvious inconsistencies present?
• Did the taxpayer ask reasonable questions?
• Was relevant information withheld from the preparer?
• Did the taxpayer deliberately avoid reviewing suspicious information?

The result depends on the particular facts rather than a blanket rule.

Are Gross Negligence Penalties Common in Net Worth Audits?

Gross negligence penalties can arise in CRA net worth assessments, particularly where the CRA alleges that substantial income was omitted.

However, a net worth calculation does not itself prove the taxpayer’s state of mind.

The underlying net worth assessment and the penalty should therefore be analyzed separately.

For more information, see our CRA Net Worth Audit guide.

How Can You Challenge a Gross Negligence Penalty?

A challenge should address both the legal test and the factual evidence relied upon by the CRA.

Potential issues may include:

• Whether there was actually a false statement or omission;
• Whether the taxpayer knew the return was incorrect;
• Whether the conduct amounted to gross negligence rather than ordinary negligence;
• Whether the CRA improperly relied on another person’s conduct;
• Whether the CRA’s assumptions are supported by evidence;
• Whether the taxpayer reasonably relied on professional advice;
• Whether alleged wilful blindness can actually be established; and
• Whether the penalty calculation itself is correct.

Can You Object to a Gross Negligence Penalty?

Yes.

A gross negligence penalty included in a CRA reassessment can generally be challenged through the Notice of Objection process.

The objection should address the underlying reassessment as well as the factual and legal basis for the penalty where both are disputed.

For information about objection deadlines and procedure, see our Notice of Objection (T400A) guide.

For legal representation, visit our CRA tax objection lawyers page.

Can Gross Negligence Penalties Be Challenged in Tax Court?

Yes.

If the objection process does not resolve the dispute, the taxpayer may have a right to appeal the penalty to the Tax Court of Canada.

At Tax Court, the Minister bears the statutory burden of establishing the facts justifying the penalty.

The evidence may include:

• The taxpayer’s testimony;
• Tax returns;
• Accounting records;
• Emails and correspondence;
• Evidence from accountants or tax preparers;
• CRA audit records;
• Banking records; and
• Other evidence concerning the taxpayer’s knowledge and conduct.

For more information about the litigation process, see our Tax Court of Canada procedure guide.

What Is the Difference Between Gross Negligence and Criminal Tax Evasion?

A gross negligence penalty under subsection 163(2) is a civil tax penalty.

It is not the same as a criminal conviction for tax evasion.

Criminal tax proceedings involve different statutory provisions, procedures, evidentiary standards, and consequences.

However, particularly serious allegations of deliberate tax misconduct can sometimes raise both civil and criminal concerns.

For more information, visit our criminal tax investigation lawyers page.

How Our Tax Lawyers Assist With Gross Negligence Penalties

KR Law Firm represents individuals and businesses in CRA disputes involving gross negligence penalties, unreported income, net worth assessments, and other tax reassessments.

Depending on the matter, our tax lawyers can assist with:

• Reviewing the CRA’s penalty recommendation;
• Assessing whether the statutory requirements for the penalty are satisfied;
• Reviewing the evidence relied upon by the CRA;
• Responding to proposed penalty assessments;
• Preparing Notices of Objection;
• Challenging allegations of wilful blindness;
• Challenging net worth reassessments;
• Preparing evidence and legal submissions; and
• Representing taxpayers before the Tax Court of Canada.

Frequently Asked Questions About CRA Gross Negligence Penalties

What is a gross negligence penalty?

It is a civil tax penalty that may apply where a taxpayer knowingly, or under circumstances amounting to gross negligence, makes or participates in a false statement or omission.

How much is the income tax gross negligence penalty?

Under subsection 163(2), the penalty is generally the greater of $100 and 50% of the amount determined under the statutory formula relating to the false statement or omission.

Does unreported income automatically result in a gross negligence penalty?

No. The CRA must establish the facts necessary to justify the penalty. Unreported income alone does not automatically prove knowing conduct or gross negligence.

Who has the burden of proving gross negligence?

When a subsection 163 penalty is disputed in an appeal, the Minister bears the burden of establishing the facts justifying the penalty.

Can relying on an accountant prevent the penalty?

It can be relevant, but it does not automatically eliminate the penalty. The circumstances surrounding the preparation, review, and filing of the return must be considered.

Can a spouse’s conduct prove that I was grossly negligent?

Not by itself. The evidence must support the penalty against the particular taxpayer. The Khanna decision illustrates the importance of examining each taxpayer’s own knowledge and conduct.

Can I appeal a CRA gross negligence penalty?

Yes. A taxpayer can generally challenge the penalty through a Notice of Objection and, if necessary, appeal to the Tax Court of Canada.

Speak With a Tax Lawyer About CRA Gross Negligence Penalties

Gross negligence penalties can substantially increase a tax reassessment and often turn on detailed evidence about what the taxpayer knew, what steps were taken when preparing the return, and whether the conduct actually met the legal threshold for gross negligence.

KR Law Firm represents taxpayers in CRA audits, objections, gross negligence penalty disputes, and Tax Court appeals.

Book a Free Consultation with one of our tax lawyers to discuss a CRA gross negligence penalty.

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By Kaveh Rezaei – Principal Lawyer, KR Law Firm

Disclaimer: This article provides general information only and does not constitute legal advice. Gross negligence penalty disputes depend on their particular facts, evidence, applicable legislation, and procedural history.