Statute Barred Years Are Important to Understand
Statute Barred Years
3 Year Rule
This whole issue around statute barred years seems to confound a lot of people, including the Canada Revenue Agency.
Generally, CRA, often referred to as “The Minister” cannot reassess a taxation year after the normal reassessment period of three years has passed.
A tax year is considered as statute barred 3 full years after the date on your original notice of assessment issued from CRA, and not your reassessment dates.
Statute barred years should not be confused with the retention of records. Section 230 of the Income Tax Act requires that you retain all books and records until six years after the date the return is filed. You would need those records if a statute barred year was opened up.
Unlike Income Tax, the GST/HST is four years from the date the GST/HST Tax Returns were due to be filled.
For example: Income Tax returns are statute-barred three years after the earlier of the Notice of Assessment or a notice to you that states no taxes are payable. If you file your 2005 tax return and the Notice of Assessment is dated June 30, 2006, the government is not allowed to question your 2005 tax return after June 30, 2009.
Regarding proving “gross negligence,” as in the tax court case of Francisco v The Queen in 2003, the Tax Court of Canada found that the burden of proof shifted to the CRA on statute-barred years. In other words, if the government is going to go after a taxpayer, they need to prove their case rather than have the taxpayer defend against the CRA allegations.
In non-statute barred years, you simply have to be able to prove your income and expenses. However, GAAP (Generally accepted accounting principles) make audits a nightmare for Canadians. Very few businesses keep truly audit ready books.
There are two conditions that allow the opening of stature barred years by CRA. One is if the taxpayer foolishly signs a waiver of the time limit and the other is if the taxpayer made a misrepresentation attributable to neglect, carelessness or willful default or fraud. One of those conditions would normally be referred to as constituting “Gross Negligence.”
The other reason would be the signing of a waiver. Taxpayers are often requested to provide a Waiver, allowing the Statute Bar period to be extended indefinitely. CRA threatens they will reassess unless the Waiver is signed. In almost every instance, they are going to reassess anyway – the Waiver just gives them more time to gather information to be used against you. The decision as to whether to provide a waiver or not should be made in consultation with your tax representative.
Note that the minister has to provide you with the proper prescribed form in order for you to sign off on your rights of preventing an audit of statute barred years. A good general rule is go get solid professional advice before signing any CRA forms.
Waivers are open-ended and remain in effect until the Taxpayer revokes it in writing. There is a notation on the top of the Waiver provided by CRA, that CRA will not accept waivers if you try to write in a time limit. They give the Agency a great advantage by allowing them as long as they want to find new reasons to reassess you. If you have already signed and returned a Waiver, you should consider sending in a Revocation of Waiver, which will take effect 6 months from the date you deliver it to CRA and reestablishes the years as statute barred. If you are doing a revoking, make sure you use the prescribed form as required by the income tax act.
If one of those two aforementioned conditions applies, the Minister could reassess the taxation year at any time after the normal reassessment period, but only in respect of the particular subject matter of the waiver or misrepresentation. It is a critical point of law to note that the assessment going back into statute barred years only applies to the particular subject matter.
If the Minister reassesses a taxation year after the normal reassessment period, the Minister has the onus of establishing the right to do so, by proving that the taxpayer either waived the time limit or was grossly negligent in order for the Minister to justify a late reassessment.
Proving Gross Negligence is very hard to do, so one should not roll over easily and accept gross negligence penalties from CRA. When CRA attempts to levy said penalties, one should be fight this with full vigor.
It is important to know that Gross Negligence is not just making a mistake on your tax return. Gross Negligence is much more than a simple error or omission. In this regard, any error in a return is considered to be “misrepresentation”. It is a separate question to determine whether the “misrepresentation” was merely an innocent mistake or was attributable to neglect, carelessness or willful default or fraud. If you had clean hands and honestly believed your tax return was correct, at the time of signing and sending the return into CRA, then there is a very slim chance that CRA could make their claim of gross negligence stick.
One needs to consider risk management when doing a loss carry back on a tax return. The normal reassessment period for a taxation year will be extended from three to six years if the taxpayer claims the benefit of a loss carry-back from a subsequent taxation year. However the access is limited to the particular subject matter and not the rest of your tax return. Keep in mind, that you may not want CRA looking at your past tax returns.
If the tax years in question are not statute barred, The Minister may at any time make an assessment, reassessment or additional assessment of tax for a taxation year, and charge; interest or penalties.
Where a taxpayer or CRA wish to open up a statute barred year for their own particular reasons, the following tax court case is critical to understand.
Chief Justice Gerald J. Rip of the Tax Court of Canada invoked Ralph Waldo Emerson when summing up a case he decided last month(Leola Purdy, Sons Ltd. v The Queen, 2009 TCC 21) – “A foolish consistency is the hobgoblin of little minds.”
The dispute, which began as a classic question of income vs. capital gains treatment, became a lot more interesting when a secondary issue arose: whether you can carry forward a loss, which was not originally reported, from a tax year that is otherwise “statute-barred.”
In 2005, the CRA reassessed Leola and found the $1.2 million capital gain in 2002 should have been reported as income since it constituted a business activity. As a result, instead of it being half taxable, it became 100% taxable.
While the judge agreed that “1998 is a lost cause” since it had already been assessed and the assessment was now statute-barred, an error made in correctly assessing the true nature of Leola’s trading activity in 1998 had an impact on the corporation’s 2002 taxation year.
Allowing the non-capital loss carry forward, the judge wrote, “Nobody is saying that a statute barred year can be reassessed. The tax the taxpayer has been assessed for the statute-barred year cannot be changed. But it’s valid and binding only for the year assessed. If an error was made in the assessment of the statute-barred year, which affects another year, the (CRA) in assessing the other year, must follow the Act and if there was an error in law in a previous year, including a statute-barred year, that error ought to be corrected.”
So all in all, what all businesses in Canada need to fully realize: You have to keep audit ready records. Failing to do so caused headaches. Our society is one where there is no pity for the entrepreneur who fails to keep good books and records. The government agencies live to feast on the bank accounts of those who would not heed this advice.