When fake tax losses lead to CRA gross negligence penalties: The risk of willful taxpayer blindness

David J Rotfleisch, CPA, JD is the founding tax lawyer of Taxpage.com and Rotfleisch & Samulovitch P.C., a Toronto-based boutique tax law corporate law firm.

Overview: When Tax Reassessments, Fake Loss Claims, and Gross Negligence Penalties Collide

In McCutcheon v. The King, 2026 TCC 57, the Tax Court of Canada considered whether penalties imposed by the Canada Revenue Agency (CRA) as part of a tax reassessment were justified where a taxpayer relied on third-party tax preparers to claim fictitious business and capital losses. The case arose from multiple tax reassessments issued by the CRA for the 2010, 2011, and 2012 taxation years, in which the CRA disallowed losses that had no basis in reality and imposed gross negligence penalties under subsection 163(2) of the Income Tax Act.

Importantly, the taxpayer did not dispute the tax reassessment itself. The taxpayer accepted that the claimed losses were false. Instead, the dispute revolved around whether the penalties should be imposed, given that the taxpayer argued he relied on external advisors and did not fully understand the reporting positions taken on his behalf.

The Tax Court rejected that position. The Court confirmed that reliance on a tax preparer does not shield a taxpayer from penalties where the surrounding circumstances give rise to clear warning signs. Where those warning signs exist, and the taxpayer fails to make reasonable inquiries, the doctrine of willful blindness applies. In such cases, knowledge is imputed to the taxpayer, and the penalties imposed as part of the tax reassessment will be upheld.

More broadly, McCutcheon reinforces a fundamental principle of Canadian tax litigation: once the CRA issues a tax reassessment, it is presumed to be valid, and the burden shifts to the taxpayer to challenge its factual basis. That burden becomes particularly difficult to meet where the taxpayer’s conduct demonstrates deliberate ignorance or a conscious decision not to verify suspicious claims.

In this sense, McCutcheon is not simply a case about improper tax filings. It is a cautionary decision on the limits of relying on tax preparers, the scope of willful blindness, and the serious consequences that arise when a taxpayer fails to question reporting positions that are too good to be true. 

How the Taxpayer Became Involved in a Fraudulent Tax Scheme

The taxpayer had a long-standing history of filing his income tax returns through a trusted accountant for nearly 15 years. During that time, there were no issues with his filings. This changed when the taxpayer decided to end that professional relationship and instead relied on third-party tax preparers introduced through informal channels.

At the relevant time, the taxpayer was living a largely rural lifestyle, splitting his time between locations in British Columbia and Northwestern Ontario. Despite this, he was still able to manage his financial affairs and communicate with the individuals involved in preparing his returns.

The taxpayer was first introduced to Fiscal Arbitrators through a “friend of a friend.” He had no prior relationship with this organization and never met its representatives in person. Nonetheless, he allowed them to prepare and file his tax return.

Fiscal Arbitrators was later found in other proceedings to be part of a fraudulent scheme involving the reporting of fictitious business losses from non-existent activities. Individuals associated with that organization were ultimately convicted of fraud.

Instead of distancing himself from this kind of arrangement, the taxpayer was then directed — through the same informal network — to a second organization, DeMara Consulting Inc., which operated out of Vernon, British Columbia. Without performing independent verification or consulting a qualified professional, the taxpayer moved on to this new group.

DeMara promoted what it called a “tax remedy.” The main idea of this program was to treat personal living expenses as business expenses and capital losses. Participants had to provide detailed personal financial information and sign confidentiality and non-disclosure agreements. The organization then prepared and filed tax returns claiming losses unrelated to any real business activity.

The taxpayer followed this process and allowed DeMara to amend his previous return and prepare subsequent tax returns based on this so-called “remedy.” At no point was the taxpayer engaged in a business that could generate the reported losses. The losses claimed in the returns were entirely fictitious.

What is particularly notable is that the taxpayer did not rely on a single questionable tax preparer. After becoming aware of issues with Fiscal Arbitrators, he moved directly to another organization offering a similar scheme. In doing so, he effectively continued — and reinforced — his participation in a structure designed to generate artificial tax losses.

Following a tax audit, the CRA issued tax reassessments disallowing the claimed losses and imposing penalties. The taxpayer did not dispute that the losses were not genuine. The main issue became whether he could avoid penalties by claiming that he relied on third-party tax preparers.

Willful Blindness and Penalties Under Subsection 163(2): When the Taxpayer Is Deemed to Have Known

A key issue in this case is whether the penalties imposed by the CRA as part of the tax reassessment were justified under subsection 163(2) of the Income Tax Act. That provision applies when a taxpayer makes or is involved in a false statement in a tax return, either knowingly or through circumstances amounting to gross negligence.

In this case, there was no dispute that the taxpayer’s returns contained false statements. The claimed losses had no factual basis. The only question was whether the taxpayer’s conduct met the threshold required for penalties.

The Tax Court emphasized willful blindness. This principle applies when a taxpayer becomes aware of circumstances that clearly call for inquiry but deliberately chooses not to investigate. In such cases, the law assigns knowledge to the taxpayer. It is not necessary to prove that the taxpayer actually knew the statements were false. It is sufficient that the taxpayer suspected something was wrong and consciously avoided confirming it.

Willful blindness is therefore a form of deliberate ignorance. Where warning signs exist, and the taxpayer declines to ask questions, seek advice, or verify the reporting position, the knowledge requirement under subsection 163(2) is satisfied. In practical terms, the taxpayer is treated as having known that the statements were false.

Gross negligence is different. Gross negligence arises where a taxpayer’s conduct is found to fall markedly below what would be expected of a reasonable taxpayer. As the Federal Court of Appeal stated in Wynter, “if the willfully blind taxpayer knew better, the grossly negligent taxpayer ought to have known better.”

In this case, the Court determined that the taxpayer’s conduct satisfied the willful blindness standard. Consequently, knowledge was attributed, and the penalties from the tax reassessment were upheld.

Red Flags Everywhere: Why the CRA Upheld the Tax Reassessment and Penalties

The Court’s analysis focused on whether the taxpayer ignored a series of warning signs that clearly called for inquiry before filing his returns. Drawing from Torres v. The Queen, the Court examined the surrounding circumstances to determine whether the taxpayer’s conduct supported a finding of willful blindness.

The taxpayer attempted to present himself as unsophisticated, living a rural and largely disconnected lifestyle. However, the Court did not accept that characterization. He was educated, articulate, and capable of managing his affairs. His own communications with the tax preparers demonstrated that he was engaged, able to ask questions, and capable of understanding what was being proposed. In this context, the suggestion that he lacked even a basic understanding of what was occurring did not withstand scrutiny.

The magnitude of the claimed losses was another critical factor. The taxpayer reported significant business losses that offset virtually all of his income and generated refunds. These were not minor adjustments or technical interpretations of the law. They were dramatic outcomes that fundamentally altered his tax position. When a taxpayer is presented with unusually favourable results, this creates an obvious need for inquiry. The failure to question such results supported the CRA’s position in issuing the tax reassessment and associated penalties.

Equally important was the blatant nature of the false statements. The taxpayer was not carrying on any business, yet the returns reported substantial business losses. This was not a complex or ambiguous issue. As the Court emphasized, even if a taxpayer believes he is entitled to a refund, that does not mean he could reasonably believe that non-existent business losses actually exist. The contradiction was clear, and the taxpayer did not address it.

The structure of the arrangement itself was filled with red flags. The taxpayer was introduced to unknown preparers through informal channels, was presented with a so-called “tax remedy,” and was required to enter into confidentiality and non-disclosure agreements. Communications were conducted in vague, coded language. He was instructed to obtain a business number and to operate accounts under a non-existent business name. These are not hallmarks of legitimate tax planning. They are warning signs that would prompt any reasonable taxpayer to seek clarification.

The evidence further showed that the taxpayer actively participated in elements of the scheme. He obtained a business number, opened and used a business account, and characterized transactions as “shareholder loans,” despite there being no corporation or business activity. This was not a case of passive reliance. At a minimum, it demonstrated that the taxpayer was aware that something was amiss and chose not to confront it.

Perhaps most damaging was the complete absence of independent advice. The taxpayer had previously relied on a trusted accountant for many years without issue, yet he did not consult that advisor when adopting this new filing position. He did not seek a second opinion, did not contact the CRA, and did not verify the legitimacy of the scheme, despite public warnings about similar arrangements. The Court viewed this failure to inquire — despite multiple opportunities — as central to the finding of willful blindness.

In the end, the Court concluded that the taxpayer faced multiple, obvious warning signs but chose not to investigate because he did not want to know the truth. In those circumstances, the CRA was entitled to treat the taxpayer as having knowledge of the false statements and to uphold the penalties as part of the tax reassessment.

Willful Blindness Seals the Outcome: When Ignoring the Obvious Becomes Liability

The Court concluded that the taxpayer ignored clear warning signs that required inquiry into the accuracy of his filing positions. Rather than verifying the arrangements’ legitimacy, he chose not to ask questions and effectively avoided confirming what might have been an inconvenient truth.

Importantly, the taxpayer did not rely on a single promoter. He moved from Fiscal Arbitrators to DeMara, reinforcing the same questionable approach. In the Court’s view, this pattern showed that he had multiple opportunities over several years to investigate but deliberately chose not to do so — effectively “doubling down.”

In this context, the Court found that willful blindness was established, and knowledge was therefore imputed for subsection 163(2) of the Income Tax Act. As a result, the taxpayer was liable for gross negligence penalties for the 2010, 2011, and 2012 taxation years.

The decision in McCutcheon makes clear that disputes involving false loss claims and penalties under subsection 163(2) do not turn on whether a taxpayer relied on a third party, but on whether the surrounding circumstances required further inquiry.

David J Rotfleisch, CPA, JD is the founding tax lawyer of Taxpage.com and Rotfleisch & Samulovitch P.C., a Toronto-based boutique tax law corporate law firm and is a Certified Specialist in Taxation Law who has completed the CICA in-depth tax planning course. He appears regularly in print, radio and TV and blogs extensively.  

With over 30 years of experience as both a lawyer and chartered professional accountant, he has helped start-up businesses, cryptocurrency traders, resident and non-resident business owners and corporations with their tax planning, with will and estate planning, voluntary disclosures and tax dispute resolution including tax audit representation and tax litigation. Visit www.Taxpage.com and email David at david@taxpage.com.

Read the original article in full on Taxpage. Author photo courtesy Rotfleisch & Samulovitch P.C. The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances. Title image: iStock ID: 932103656..