How is the CRA penalty for repeatedly failing to report income calculated?
For 2026 returns, the federal repeated failure to report income penalty under ITA s.163(1) is the lesser of 10% of the unreported amount and half of the understated tax net of tax withheld on it. It applies only when your client left out $500 or more this year and $500 or more in one of the three preceding years.
When does the s.163(1) penalty apply?
The penalty needs a repeat. Your client must leave out $500 or more of income on a filed return for the year, and must also have left out $500 or more on a return for any of the three preceding taxation years laws-lois.justice.gc.ca. For a 2025 return, the CRA reads that as a failure on the 2025 return plus one on the 2022, 2023 or 2024 return
canada.ca.
| Condition in s.163(1) | What it means for your client |
|---|---|
| Current omission of $500 or more | An amount required to be included in income, left off a return that was filed |
| Earlier omission of $500 or more | Left off a return filed for any of the three preceding taxation years |
| No gross negligence penalty on the same amount | If s.163(2) applies to that amount, s.163(1) does not |
| Federal penalty | Lesser of 10% of the unreported amount and 50% of (understated tax minus tax withheld on it) |
| Provincial or territorial penalty | A matching penalty outside Quebec, for a combined federal and provincial charge |
The rule only reaches income. The section speaks of an amount required to be included in computing income, so an overclaimed deduction or credit is not an unreported amount under s.163(1) laws-lois.justice.gc.ca. Nothing in the subsection asks whether your client meant to leave the amount out.
How the penalty is calculated
Subsection 163(1.1) sets the federal penalty at the lesser of 10% of the unreported amount and 0.5 × (A minus B). A is the understated tax and overstated refundable credits that the gross negligence rules in s.163(2) would compute on that amount. B is tax withheld under s.153(1) that relates to it laws-lois.justice.gc.ca.
With no withholding, the second option is half your client's marginal federal rate on the omission. Against the 2026 federal rates, the 50% option only wins in the lowest bracket canada.ca.
| 2026 federal rate | Taxable income band | Half the rate | Federal penalty with no withholding |
|---|---|---|---|
| 14% | $0 to $58,523 | 7% | 7% of the omission |
| 20.5% | $58,523.01 to $117,045 | 10.25% | 10% |
| 26% | $117,045.01 to $181,440 | 13% | 10% |
| 29% | $181,440.01 to $258,482 | 14.5% | 10% |
| 33% | Over $258,482 | 16.5% | 10% |
The table is a shortcut. A comes from the actual reassessment, so an omission that pushes income across a bracket line, or changes credits, blends the rates.
Worked example: same mistake, two brackets
Both clients left $500 or more of income off their 2024 return. On the 2026 return, neither reports a T5, and no tax was withheld on the interest. Figures are federal only and assume no other change to credits.
| Step | Client A | Client B |
|---|---|---|
| Reported taxable income | $70,000 | $40,000 |
| Unreported T5 interest | $8,000 | $6,000 |
| Federal rate on the omission | 20.5% | 14% |
| Option 1: 10% of the omission | $800 | $600 |
| Understated federal tax (A) | $1,640 | $840 |
| Tax withheld (B) | $0 | $0 |
| Option 2: 0.5 × (A minus B) | $820 | $420 |
| Federal s.163(1) penalty (lesser) | $800 | $420 |
Client A's $8,000 keeps income at $78,000, inside the 20.5% band, and Client B's $6,000 keeps income at $46,000, inside the 14% band canada.ca. Client B pays an effective 7%. Outside Quebec, the province adds its own penalty on top of each figure
canada.ca.
Where withholding changes the answer
Withholding is why Budget 2015 replaced the old flat 10% with the lesser of test, for unreported amounts in tax years beginning after 2014 canada.ca. The CRA's own example is a New Brunswick client who left out a $30,000 RRSP withdrawal with $9,000 withheld.
| Step | Amount |
|---|---|
| Old flat rule: 10% federal plus 10% provincial on $30,000 | $6,000 |
| Understated federal tax: $30,000 × 22% | $6,600 |
| Understated provincial tax: $30,000 × 14.82% | $4,446 |
| Total understated tax | $11,046 |
| Less tax withheld | $9,000 |
| Net | $2,046 |
| 50% of the net | $1,023 |
The penalty falls from $6,000 to $1,023, and the CRA notes that this example combines the federal and provincial calculations canada.ca. The 22% and 14.82% are the rates in the CRA's example, not 2026 rates. The lesson holds: on a missed RRSP withdrawal or T4A with tax withheld, the 50% option often wins by a wide margin.
Edge cases accountants hit
Quebec. Only the federal penalty applies to a Quebec resident, because Revenu Québec assesses the provincial tax. Non residents and deemed residents. The provincial or territorial penalty applies only if provincial or territorial tax is payable canada.ca.
Gross negligence. If the CRA assesses the s.163(2) penalty on the same amount, s.163(1) cannot apply to it laws-lois.justice.gc.ca. The s.163(2) penalty is the greater of $100 and 50% of the understated tax or overstated credits, so it is usually the larger one
canada.ca. See the gross negligence penalty.
Interest. Interest on a section 163 penalty runs from the day the return was required to be filed, not from the date of the reassessment laws-lois.justice.gc.ca. As of October 2026, the CRA charges 7% on overdue amounts for October 1 to December 31, 2026
canada.ca. More on the overdue tax rate.
Burden of proof. When your client appeals a section 163 penalty, the Minister has to establish the facts that justify it laws-lois.justice.gc.ca.
Getting the penalty reduced or removed
The cleanest fix is disclosure before the CRA calls. The CRA may reduce or waive the penalty if your client discloses the unreported amounts before the CRA contacts your client or a related person canada.ca. Under the Voluntary Disclosures Program, an unprompted application gets 100% relief of applicable penalties and 75% of interest, and a prompted one gets up to 100% of penalties and 25% of interest
canada.ca. Details are on the VDP page.
Once the penalty is assessed, taxpayer relief is the other route, for circumstances beyond your client's control, and the CRA can grant it only within 10 years of the request date canada.ca.
Sources
Does the earlier year have to have been penalized or reassessed?
No. Paragraph 163(1)(b) asks only whether your client had failed to report $500 or more on a return for any of the three preceding taxation years laws-lois.justice.gc.ca. A first omission found during the same review can count as the earlier failure.
Is the $500 test applied to the penalty or to the income?
To the income. Each of the two omissions must be an amount of income of $500 or more; the penalty itself can be far smaller, like the $420 in the worked example above laws-lois.justice.gc.ca.
Can the CRA charge both s.163(1) and s.163(2) on the same income?
No. Paragraph 163(1)(c) excludes the repeated failure penalty when your client is liable to the gross negligence penalty on that unreported amount laws-lois.justice.gc.ca. The CRA can still apply s.163(1) to a different omission on the same return.
Does the penalty apply when my client never filed the return?
No. Subsection 163(1) applies to an amount left off a return that was filed, so an unfiled year cannot be the current omission laws-lois.justice.gc.ca. A year with no return at all falls under the late filing rules instead.
General information for the tax year shown, not advice for a specific client. Confirm the facts before you file or remit.