Look Out — The Government Seems To Be Banking On Increased Tax Penalties To Help Pay For Its Spending

Have you ever been assessed a penalty or interest amount on your personal tax return or a corporate tax return you are responsible for? Not fun, eh? Penalties are used by countries as a carrot-and-stick approach in order to encourage behaviour that is in line with expectations. Interest is the price you pay for not paying your taxes on time.

Penalties are generally broken down into two types: civil and criminal. If you purposely didn’t report your income and/or file your tax returns, that is tax evasion and criminal. The penalties are significant and can include jail time.

Civil penalties are administrative in nature and can encompass a wide variety of circumstances, including late filing, underreporting your income, not reporting certain forms (such as foreign assets), etc.

Lately, there has been a wide variety of new civil penalties introduced into our tax statute . For example, there are now broad and complex mandatory disclosure rules requiring taxpayers to proactively disclose certain transactions. Failure to comply comes with significant penalties, in some cases $100,000 or more.

In addition, there are significant new penalties to the extent that the general anti-avoidance rule applies to one or more of your transactions and you have not proactively disclosed such transactions to the Canada Revenue Agency .

In general, you can understand the need for penalties in income tax statutes. Without them, you might simply not comply with a requirement, whereas another person complies. How would that be fair?

Accordingly, the primary intent of penalties is to encourage compliance with tax law, not to increase overall government revenues . A government that budgets material amounts for penalties as a recurring revenue stream contradicts that intent because it implies an expectation or reliance on taxpayer failure .

In Canada, our overall tax compliance rate is high. The on-time filing rate — the share of expected tax returns filed by the due date — is above average as compared to other Organization for Economic Co-operation and Development (OECD) member countries and compares well to G7 members.

Canada’s on-time payment rate — the share of taxpayers who have paid their tax amounts by the payment due dates — is also very comparable to peer countries.

The above metrics don’t paint the whole picture since civil penalties can encompass a wide variety of penalties, not just ones for late filing and late payment amounts, but it is a decent snapshot that shows Canada is not a country rife with non-compliance.

For the 2024 fiscal year, the CRA  collected approximately $14.2 billion in interest, penalties and other revenues. This represents a significant increase from the $10.6 billion collected in the previous fiscal year and is largely attributed to higher prescribed interest rates and increased arrears interest. As interest rates move down, you would expect these amounts to decrease as well.

But during the recent election campaign, the Liberal Party was budgeting for increased income tax penalties to fund some of its initiatives. Starting next year, it said it is expecting its government to collect $3.75 billion in new penalties over the following three years.

No details were provided on the computation of these estimated new amounts, but they are part of the $51.75 billion the government expects to raise in overall new revenues over the next four years. Accordingly, the increased penalties represent 7.2 per cent of the new expected revenues. Not an insignificant amount.

What is that telling you? Well, it could mean a number of things.

To start, there are no increased penalties budgeted for the current year. Why? Is the government, through the CRA, only going to start assessing new penalties next year? Is there an obvious lag with the new penalties that have been introduced into law versus collection? I’m not sure, but the estimate for nil seems silly.

Second, the increase in penalties sends a strong contradictory message from what the policy intent of penalties should be. If penalties are used as a recurring budgetary item, then the government is essentially budgeting for taxpayer failure. Is it finally admitting that our tax statutes are too complex? If so, there is a good solution: tax reform .

Unfortunately, the Liberals only seem interested in a so-called “expert review” of the corporate tax system and not an overall review of our entire tax system.

Third, does it mean the CRA will become even more aggressive than it already is? Haven’t had an audit lately? Well, count your lucky stars. Unfortunately, the CRA’s massive increase in headcount has not improved audit quality and has resulted in frustrating overall services.

Fourth, if a government needs to count on billions in new revenue from penalties, such budgeting is reflective of underlying fiscal pressures, not genuine tax concerns. It is fiscally shortsighted and ethically questionable, especially if the penalties are applied as negotiating tactics on audits.

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The devil is in the details so we’ll have to wait to see if the Liberals’ first post-election budget is reflective of the above proposal, but such a plan appears reckless.

Our federal government is addicted to deficit spending and plans to finance some of that spending by betting on Canadians failing to navigate a byzantine tax system it keeps expanding. You’re not managing a tax system when penalties become an increasing and recurring line item in your fiscal framework; you’re running a shakedown.

To quote AC/DC, “If you want blood, you got it.” Apparently, so do the Liberals and they’re coming for yours, one penalty at a time. Dirty deeds, done expensively.

Kim Moody, FCPA, FCA, TEP, is the founder of Moodys Tax/Moodys Private Client, a former chair of the Canadian Tax Foundation, former chair of the Society of Estate Practitioners (Canada) and has held many other leadership positions in the Canadian tax community. He can be reached at kgcm@kimgcmoody.com and his LinkedIn profile is https://www.linkedin.com/in/kimgcmoody.

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