Principal Issues: [TaxInterpretations translation] Can the penalty under subsection 163(1) apply when a person claims, for a second consecutive taxation year, expenses that are not allowed as deductions under the Income Tax Act?
Position: No.
Reasons: This penalty applies only where a person fails to include a "gross" amount in computing income for a particular taxation year.
June 25, 2009
Jonquière Tax Services Office Headquarters Business and Partnerships Division Attention: Caroline Labrecque François Bordeleau, Advocate
2009-032817
Application of subsection 163(1) to non-permitted expenditures
This is further to your email of June 18, 2009 requesting our opinion regarding the application of the penalty under subsection 163(1) of the Income Tax Act (the "Act").
Specifically, you referred to a situation where an individual, as part of a fraudulent scheme, claimed fictitious expenses in computing the individual’s income for the 2006 taxation year. An adjustment was made to the individual's return and a penalty under subsection 163(2) was assessed. For the 2007 taxation year, the same individual failed to report income but the penalty under subsection 163(2) was not considered. However, you wish to know if the penalty under subsection 163(1) could be considered on the basis that this is the taxpayer's second failure.
Unless otherwise indicated, all statutory references herein are to the provisions of the Act.
Our Comments
The relevant portion of subsection 163(1) is reproduced below:
Every person who … 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… 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 […] (Emphasis added.)
The Explanatory Notes of the Department of Finance dealing with the penalty in subsection 163(1) read as follows:
This penalty will typically apply to the suppression of amounts that are included in determining net income, but will not normally apply to understatements of income attributable to errors in the characterization of income or in its computation if all amounts required to be included in computing income are reported.
Previously, the Income Tax Rulings Directorate had expressed the view that the penalty under subsection 163(1) should be calculated on the basis of the gross amount that should have been included in computing a person's income for a particular taxation year and not on the net amount (i.e., the amount that has not been included in computing income net of any deduction that is allocable to that amount).
Consequently, where a person claims unjustified expenses in respect of a particular amount of income, we do not believe that the penalty under subsection 163(1) can apply since it is not in those circumstances a failure to report an amount that should have been included in computing income for a particular year.
Access to Information
For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, the electronic library version can be provided. Alternatively, the client may request a severed copy using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Ms. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.
We hope that these comments are of assistance.
François Bordeleau, Advocate
Manager
Business and Partnerships Section
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch.