Illustrative example based on the kinds of matters we handle — not a specific client engagement; outcomes depend on the facts.
The situation
A salaried employee with a straightforward financial life came to us frightened after a CRA audit of several past returns. A friend had recommended a tax preparer who promised unusually large refunds; the preparer prepared the returns, had them signed quickly, and took a fee set as a percentage of the refund. The taxpayer received the refunds, assumed everything was in order, and moved on.
It was not. The CRA had identified the preparer as part of a pattern of filings claiming large, fabricated business losses the clients never incurred. It reassessed to remove the bogus deductions, added back the tax — and layered on gross negligence penalties under subsection 163(2) of the Income Tax Act. With penalties at roughly half the understated tax plus years of arrears interest, the demand dwarfed the original refunds — and it landed on someone who had never knowingly claimed a thing.
The challenge
A gross negligence penalty is not the same as simply owing more tax. It is a punitive add-on — the CRA is alleging the taxpayer either knowingly made a false statement or did so in circumstances amounting to gross negligence. The heart of the defence is that the burden does not sit with the taxpayer.
- The CRA carries the onus on penalties. On the reassessment the taxpayer generally has to displace the CRA's assumptions, but on a 163(2) penalty the Minister must prove the facts justifying it.
- The threshold is high. Gross negligence means well beyond ordinary carelessness — a high degree of negligence tantamount to intentional acting, or indifference as to whether the law is complied with.
- Wilful blindness is the pressure point. Where a preparer commits the actual fraud, the CRA often argues the taxpayer was wilfully blind — that warning signs were so obvious the taxpayer must have chosen not to look.
- The signals cut both ways. A percentage-of-refund fee and returns the client never reviewed can be cast as red flags; the defence must explain why, for this taxpayer, they were not.
The real difficulty was that the deductions were plainly false; the tax itself was not in play. The fight that mattered was the penalty — and that turned on the taxpayer's own state of mind and conduct, not the preparer's wrongdoing.
How we approached it
We started where clients tell us it matters most: explaining, in plain terms, that a penalty is a fight separate from the tax. Then we set out a written strategy and built the record.
- Separated the tax from the penalty. We accepted the fabricated deductions could not stand, which let us challenge the gross negligence penalty rather than relitigate losing ground.
- Reconstructed what the taxpayer actually knew. We documented the limited financial sophistication, the trusted referral, and the absence of any benefit the taxpayer understood to be improper.
- Met the wilful blindness theory head-on. We addressed each "red flag" the CRA relied on, showing an ordinary, unsophisticated taxpayer would not have read those facts as a signal to investigate — the standard is whether this person deliberately avoided an obvious inquiry, not whether a tax professional would have.
- Filed and argued the objection, dealing with the CRA directly through a Notice of Objection, with a Tax Court of Canada appeal held in reserve if the penalty was not conceded.
Because preparer-driven audits can spill into indirect-income theories, we coordinated the audit representation so the file did not drift toward a net-worth audit. Where a taxpayer comes forward before an audit begins, the Voluntary Disclosure Program can sometimes head penalties off.
The outcome
Where the evidence shows an honest but unsophisticated taxpayer deceived by a dishonest preparer, the gross negligence penalty can be reduced or removed even though the underlying tax remains payable. Because the CRA must prove the conduct supporting a 163(2) penalty, a credible account that defeats the wilful blindness theory can lead the penalty to be vacated on objection or, if necessary, on appeal — leaving the taxpayer with the corrected tax and interest, not the punitive add-on. Some files resolve at the objection stage; others need a Tax Court appeal.
It is equally honest to say these matters take time and turn on the record. Reconstructing what a taxpayer knew is methodical work, and the result depends on the evidence.
The takeaway
Being defrauded by a tax preparer does not automatically make you grossly negligent. The penalty is a separate fight from the tax, the CRA carries the burden on it, and the standard is high. The strongest position is rarely "the deductions were fine" — it is usually "I was deceived, not wilfully blind." Build an honest picture of what the taxpayer knew, and the punitive layer can often come off even when the tax remains.
If you have been assessed gross negligence penalties for a preparer's wrongdoing, it helps to understand the mechanics early. Our guides on defending a subsection 163(2) penalty, appealing gross negligence penalties in Tax Court, the burden of proof and evidence, and how to file a Notice of Objection explain where these assessments can be challenged.
This is an anonymized, illustrative example. Results vary with the facts of each matter, and nothing here predicts or promises any particular outcome. For information about how we handle these files, see our overview of gross negligence penalty defence.