Nov 26, 2024
Introduction: Statute-Barred Taxation Years
Canada’s Income Tax Act generally bars the Canada Revenue Agency from reassessing a taxpayer’s taxable income or tax payable after the expiry of the “normal reassessment period.” For most taxpayers, the normal reassessment period expires three years from the date that the CRA issued the initial tax assessment for the taxation year.
When the normal reassessment period expires, the taxation year becomes statute-barred. This means that the Canada Revenue Agency can no longer tax audit that year’s income-tax return or increase that year’s tax bill. It also means that the CRA can no longer apply civil tax penalties, such as gross-negligence penalties, relating to a statute-barred taxation year. (Canada’s Excise Tax Act contains a similar tax rule, which generally prohibits the CRA from reassessing a GST/HST reporting period “more than four years after” the day that the GST/HST return was filed for that period.)
The statute-barred rule aims to promote some measure of certainty and finality in Canada’s tax system. According to the Tax Court of Canada, the statute-barred rule serves to “provide a window during which the [Canada Revenue Agency] may review and make [a tax reassessment] yet provide the taxpayer who has not made misrepresentations some certainty in their tax affairs.”: Tingley v R, [1999] 1 CTC 2177.
As this quote suggests, however, the statute-barred rule comes with qualifications. In particular, the Canada Revenue Agency may still reassess an otherwise statute-barred taxation year if, when filing the tax return for that year, the taxpayer either (i) committed fraud or (ii) made a misrepresentation attributable to neglect, carelessness, or wilful default.
Still, the CRA bears the burden of proving that the taxpayer committed fraud or made such a misrepresentation. Yet the Canada Revenue Agency’s tax auditors will often reassess otherwise statute-barred taxation years without sufficient evidence that the taxpayer committed fraud or made a misrepresentation attributable to neglect, carelessness, or wilful default.
Fuhr, et al v The King, 2024 TCC 43, provides yet another example of this practice. Faced with the Canada Revenue Agency’s lack of evidence, the Tax Court of Canada allowed the taxpayers’ appeal outright—thereby cancelling tax reassessments that imposed over $2 million in additional taxable income and about $500,000 in gross-negligence penalties.
After analyzing the legislation and jurisprudence concerning statute-barred tax years, this article examines the Tax Court’s decision in Fuhr. We conclude the article by offering pro tax tips from our expert Canadian tax-litigation lawyers on disputing a CRA tax auditor’s decision to reassess a statute-barred taxation year.
The CRA’s Right to Audit and Reassess Otherwise Statute-Barred Taxation Years: Subsection 152(4) of Canada’s Income Tax Act
Subsection 152(4) of Canada’s Income Tax Act gives the Canada Revenue Agency the right to reassess an otherwise statute-barred taxation year under any of the following three conditions:
- The taxpayer filed a waiver allowing the CRA to reassess a statute-barred taxation year.
- The taxpayer made a misrepresentation attributable to neglect, carelessness, or wilful default in filing the return or in supplying information to the CRA.
- The taxpayer committed fraud in filing the return or in supplying information to the CRA.
To reassess a statute-barred year on the basis of condition 2, the Canada Revenue Agency bears the burden of establishing, on a balance of probabilities, both: (1) that the taxpayer made a misrepresentation; and (2) that the misrepresentation was attributable to neglect, carelessness, or wilful default: Vine Estate v Canada, 2015 FCA 125, at para 24; Papier Domco Inc. v. The Queen, 2011 TCC 441, at para 11.
The Canada Revenue Agency also bears the burden of proof if it seeks to reassess a statute-barred year on the basis of condition 3. In this case, the CRA tax auditor must establish, on a balance of probabilities, that the taxpayer committed fraud.
In other words, the CRA may reassess beyond the normal reassessment period only if it establishes that it is entitled to do so, and the “[Canada Revenue Agency’s] entitlement to reassess beyond the normal reassessment period must be established by proving the existence of any of the elements set out in subparagraph 152(4)(a)(i). It is up to the [CRA’s tax auditors] to do so.”: Sarraf v the Queen, [1994] 1 CTC 2519 at 2522 (Bowman TCJ).
This means that the Canada Revenue Agency’s tax auditors cannot merely assume that a taxpayer made a misrepresentation attributable to neglect, carelessness, or wilful default. This tax jurisprudence therefore reverses the onus that would otherwise apply when other tax issues are under dispute. For the most part, in Canadian tax disputes, the Canada Revenue Agency may make factual assumptions—that is, assume the facts favouring the CRA’s position without proving that those facts are true—and the taxpayer bears the initial burden of disproving the CRA’s factual assumptions. But the Canada Revenue Agency cannot reassess a statute-barred year on this basis. The burden is flipped when it comes to subparagraph 152(4)(a)(i) of Canada’s Income Tax Act. The CRA’s tax auditor must prove, on a balance of probabilities, that the taxpayer did indeed make a misrepresentation attributable to neglect, carelessness, or wilful default. The CRA cannot merely assume that the taxpayer made such a misrepresentation.
This fundamental rule is often ignored by the CRA tax auditors. In Fuhr, et al v The King the CRA did precisely that, as is too often the case.
Fuhr, et al v The King, 2024 TCC 43
In Fuhr, et al v The King, 2024 TCC 43, Mr. Fuhr and his corporation underwent a tax audit by the Canada Revenue Agency. During the tax audit, the CRA’s tax auditor decided to employ various indirect income-verification methods, including a net-worth analysis and bank-deposit analysis. These indirect methods of income verification are inherently inaccurate. But the CRA’s advantage lies in the fact that, under Canada’s income-tax system, the taxpayer has the initial onus of rebutting the CRA’s assumptions. In other words, the Canada Revenue Agency benefits from the numerous assumptions underlying these indirect income-verification methods.
By means of the net-worth and bank-deposit analyses, the Canada Revenue Agency’s tax auditor estimated that Mr. Fuhr had failed to report a total of about $1.3 million in income for the 2011, 2012, and 2013 taxation years. The net-worth and bank-deposit analyses also led the CRA’s tax auditor to conclude that Mr. Fuhr’s corporation had failed to report about $700,000 in income for the 2012 and 2013 taxation years.
Although all these taxation years were statute-barred, the Canada Revenue Agency tax auditor decided that the results of the CRA’s indirect income-verification methods demonstrated that the taxpayers had made misrepresentations attributable to neglect, carelessness, or wilful default. This, concluded the CRA tax auditor, justified reassessing the otherwise statute-barred taxation years under subparagraph 152(4)(a)(i) of Canada’s Income Tax Act. As a result, the CRA tax auditor reassessed Mr. Fuhr and his corporation, thereby increasing Mr. Fuhr’s taxable income by over $1.3 million and increasing the corporation’s taxable income by $700,000.
The CRA tax auditor also levied a total of approximately $500,000 in gross-negligence penalties under subsection 163(2) of Canada’s Income Tax Act.
Mr. Fuhr’s Canadian tax-litigation lawyer appealed to the Tax Court of Canada and argued that the Canada Revenue Agency had failed to demonstrate that either Mr. Fuhr or his corporation made misrepresentations attributable to neglect, carelessness, or wilful default.
The court ultimately agreed. First, the CRA’s Canadian-tax litigation lawyer called no witnesses and attempted to rely entirely on cross-examination of the taxpayers’ witnesses. And although the Tax Court found that Mr. Fuhr’s testimony lacked credibility, the court noted numerous errors in the CRA’s indirect income-verification methods. For example, Mr. Fuhr received a $225,000 bank draft as part of his inheritance from his mother’s estate. Yet the CRA tax auditor inexplicably treated only $25,000 of the $225,000 as a non-taxable inheritance and classified the remaining $200,000 as taxable income. Faced with the seemingly obvious error and the absence of CRA witnesses, the court concluded that the entire $225,000 should have been treated as a non-taxable gift:
I hasten to add that I did not hear any evidence on the appropriateness of the auditor’s decision to treat two portions of the bank draft differently.
In light of the bank draft and the parties’ submissions, I find that Tim Fuhr received $225,000 from his mother in April 2011 and that the whole amount, as opposed to only $25,000, must be treated as a non-taxable source of income.
Mr. Fuhr’s Canadian tax-litigation lawyer presented the court with numerous similar calculation errors by the Canada Revenue Agency’s tax auditor. After hearing this evidence, the Tax Court of Canada concluded that the CRA’s net-worth analysis was “seriously flawed,” and it therefore couldn’t demonstrate that either Mr. Fuhr or his corporation made misrepresentations attributable to neglect, carelessness, or wilful default when filing their income-tax returns.
Hence, Mr. Fuhr’s Canadian tax-litigation lawyer not only disproved the CRA’s allegations of unreported income, but also showed that the CRA had reassessed statute-barred years without warrant. The Tax Court of Canada consequently allowed the taxpayers’ appeals—cancelling all the tax reassessments, thereby allowing Mr. Fuhr and his corporation to sidestep over $2 million in fictitious additional income and about $500,000 in unjustified gross-negligence penalties.
Pro Tax Tips – Avoiding & Disputing Statute-Barred Tax Reassessments
The statute-barred tax rule illustrates why Canadian taxpayers should file income-tax returns by the filing due dates every year. For most taxpayers, the normal reassessment period expires three years from the date that the CRA issued the taxpayer’s initial tax assessment for the taxation year. If the CRA never issues a tax assessment for a particular tax year, that year will never be statute-barred. By filing an income-tax return, you will cause the Canada Revenue Agency to issue a notice of assessment. The assessment, in turn, will start the clock on the normal reassessment period. If, on the other hand, you don’t file an income-tax return, the CRA generally won’t issue a tax assessment for that year. Hence, that year will remain vulnerable to a CRA tax audit at any time.
The Fuhr decision also illustrates the importance of retaining a knowledgeable Canadian tax-litigation lawyer. As they did in Fuhr, the CRA’s tax auditors often attempt to reassess statute-barred taxation years without first proving, on a balance of probabilities, that the taxpayer did indeed make a misrepresentation attributable to neglect, carelessness, or wilful default. Without representation by competent Canadian tax-litigation counsel, the average Canadian taxpayer will fare poorly against these CRA tactics. So, if you believe that the Canada Revenue Agency has reassessed or will attempt to reassess a statute-barred taxation year, contact one of our expert Canadian tax-litigation lawyers today. We utterly understand this area of law, and we can ensure that you deliver a forceful and cogent objection to the Canada Revenue Agency’s Appeals Division or appeal to the Tax Court of Canada.
FREQUENTLY ASKED QUESTIONS
I’ve heard that the CRA cannot begin a tax audit or issue a tax assessment after a certain period. Is this true? If so, can you explain this rule?
Yes, it’s true. Canada’s Income Tax Act sets out a “normal reassessment period,” after which the Canada Revenue Agency generally cannot reassess a person’s taxable income or tax payable. For most taxpayers, the normal reassessment period expires three years from the date that the CRA issued the initial tax assessment for a particular tax year. Once the normal reassessment period for that tax year expires, that tax year is statute-barred. Consequently, the Canada Revenue Agency can no longer audit that year’s income-tax return or increase that year’s tax bill. In addition, the CRA cannot apply civil tax penalties, such as gross-negligence penalties, relating to a statute-barred taxation year. (Canada’s Excise Tax Act contains a similar tax rule, which generally prohibits the CRA from reassessing a GST/HST reporting period “more than four years after” the day that the GST/HST return was filed for that period.)
I significantly underreported my taxable income a few years ago, but the normal reassessment period for that taxation year has now expired. Am I now safe from a CRA tax audit?
No. Although it’s generally true that a taxation year is statute-barred once the normal reassessment period for that year has expired, the statute-barred tax rule comes with qualifications. The Canada Revenue Agency has the right to reassess an otherwise statute-barred year if, when filing that year’s tax return, the taxpayer (i) committed fraud or (ii) made a misrepresentation attributable to neglect, carelessness, or wilful default. For advice on how to use the CRA’s Voluntary Disclosure Program (VDP) to reduce your exposure to tax liability, tax penalties, and criminal prosecution for tax evasion, schedule a consultation with one of our top-notch tax lawyers today.
I recently underwent a CRA tax audit, and Canada Revenue Agency’s tax auditor reassessed several tax years that I believe are statute-barred. What should I do?
The Canada Revenue Agency bears the burden of establishing, on a balance of probabilities, that you either (i) committed fraud or (ii) made a misrepresentation attributable to neglect, carelessness, or wilful default. In other words, the CRA can reassess statute-barred years only if the CRA establishes that it is entitled to do so. Yet the Canada Revenue Agency’s tax auditors will often reassess otherwise statute-barred taxation years without sufficient evidence that the taxpayer committed fraud or made a misrepresentation attributable to neglect, carelessness, or wilful default. So, if you believe that the Canada Revenue Agency’s tax auditor reassessed statute-barred tax years, speak with one of our knowledgeable Canadian tax lawyers today. We thoroughly understand this area of law, and we can ensure that you deliver a forceful, thorough, and cogent tax objection to the Canada Revenue Agency’s Appeals Division or tax appeal to the Tax Court of Canada.
DISCLAIMER: This article just provides broad information. It is only up to date as of the posting date. It has not been updated and may be out of date. It does not give legal advice and should not be relied on. Every tax scenario is unique to its circumstances and will differ from the instances described in the article. If you have specific legal questions, you should seek the advice of a Canadian tax lawyer.
