The Reliance Defence – not a blanket defence

Once a tax assessment is issued, the clock starts ticking for the CRA to reassess the taxpayer. Normally, the CRA will have a limited number of years to reassess. However, if a taxpayer (or the “person filing the return”) has made a misrepresentation in a tax filing that is attributable to neglect, carelessness, or wilful default, the CRA can reassess the year regardless of how much time has passed. This article explores whether receiving advice from a tax practitioner about a filing position can be a successful defence when arguing that a misrepresentation was not attributable to neglect, carelessness, or wilful default. Though this “reliance defence” has been successful, the courts have been critical of its validity, and interpretations of the phrase “person filing the return” may limit its use.

Process of determining misrepresentation due to neglect, carelessness, or wilful default

There are two steps in determining whether there was a misrepresentation attributable to neglect, carelessness, or wilful default. Firstly, it must be determined whether there was a misrepresentation. There is an admittedly low bar in making this determination, as it could arise innocently in many cases.  Courts have concluded that misrepresentations could be the result of mathematical errors, erroneously not including income, taking a deduction when ineligible, etc.

Once it has been determined there has been a misrepresentation, it must be determined whether the misrepresentation was attributable to “neglect, carelessness, or wilful default” for the extension of the limitation period to apply to the year in question. Generally, neglect and carelessness consider whether there was a lack of reasonable care exercised whereas wilful default involves knowingly or intentionally acting.

Premise of the defence

The reliance defense supposes that a taxpayer who consulted with a tax professional took reasonable care to address its own limitations in tax knowledge and to prevent misrepresentations. Further, since a tax professional presumably advised the tax filing was correct, the taxpayer did not knowingly or intentionally make the misrepresentation.

Person filing the return

The misrepresentation attributable to neglect, carelessness, or wilful default must be made by the taxpayer or “person filing the return” for the indefinite reassessment period to apply. The interpretation of the phrase “person filing the return” may stymie the applicability of this defence. In 2013, the Tax Court of Canada interpreted the phrase “person filing the return” to not encompass accountants. That finding was reversed in 2020 when the Tax Court concluded that “person filing the return” includes the taxpayer’s legal representative and any person properly authorized to file the taxpayer’s returns, including an external accountant. This latter finding echoes a 1996 decision by the Tax Court where the judge found negligence retains its consequences on limitation periods whether the negligence was that of the “taxpayer personally or that of the accountant or other tax return preparer who is his or her agent.” This interpretation may increase taxpayers’ liability for their representative’s neglect, carelessness, or wilful default and decrease the effectiveness of this defence.

Factors of a Successful Reliance Defense

The reliance defence is not meant to allow taxpayers to defer their responsibility to correctly report their tax information. Rather, this defence aims to address the imbalance between the complexity of the Canadian tax system and the tax expertise of the average taxpayer. The taxpayer must review its return and make reasonable inquiries regarding its accuracy prior to signing it. In considering the applicability of the reliance defence, the courts tend to consider the discoverability of the misrepresentation.

In the context of relying on a tax professional to assist with tax reporting, factors determining the discoverability of the misrepresentation include:

• Whether the taxpayer provided complete information to the tax professional;
• How easily the taxpayer could locate the correct information;
• Cause to trust (or not trust) the tax professional;
• The taxpayer’s experience and education; and,
• How obvious was the error (e.g. magnitude of the unreported amount)

A successful defence

The success of the reliance defence is highly dependent on the taxpayer’s circumstances and actions the taxpayer takes. Each taxpayer should review its tax returns carefully and make reasonable inquiries about the amounts reported, especially for material or unusual amounts. For corporate taxpayers, ensuring appropriate systems and controls are in place can be beneficial but the corporation must still undertake a proper review of any tax returns.