A stronger, broader general anti-avoidance rule (GAAR) was enacted by Parliament in one of its final acts before rising for the summer recess.
The revamped GAAR is now in effect after Bill C-59 received royal assent on June 20. The bill lowered the threshold for the rule to apply and denies tax benefits arising from avoidance transactions that result in a misuse or abuse of Income Tax Act provisions.
Amendments in C-59 expanded the definition of an avoidance transaction from one whose primary purpose is obtaining a tax benefit to a transaction where a tax benefit is “one of the main purposes.” And a transaction’s lack of economic substance now “tends to indicate” that it results in misuse or abuse.
“If there is an indication the GAAR may apply to a particular transaction, tax practitioners really need to make sure they do their due diligence and analyze all the guidance and previous case law. Then they need to communicate the information to the taxpayer, because that’s who is ultimately taking the risk,” said John Oakey, vice-president of taxation with the Chartered Professional Accountants of Canada. “That’s stuff that should always be happening, but it’s heightened right now because the GAAR is more broadly applicable than it previously was.”
If taxpayers didn’t already know about the GAAR changes, then the addition of a penalty should grab their attention, said Gergely Hegedus, partner and tax lawyer with Dentons Canada in Edmonton.
When the new GAAR is applied, the penalty is calculated as 25% of the additional tax owing by a taxpayer as a result of its application, including the value of any refundable tax credits lost. The total amount can be reduced by the value of any gross negligence penalty already imposed. The penalty also comes with a three-year extension to the limitation period for assessment or reassessment when the rule applies.
“These are huge changes,” Hegedus said. “It’s probably going to have the intended effect of making people more cautious when their tax transactions are tax motivated in any way, when considering whether GAAR potentially applies and whether it’s worthwhile to take the risk.”
Still, there was good news: the new GAAR contains an exception preventing the penalty’s imposition in cases involving transactions that are “identical or almost identical” to those that were the subject of government guidance or court decisions indicating the GAAR would not apply.
In addition, taxpayers can avoid penalties and reassessments related to transactions disclosed under the Canada Revenue Agency’s new mandatory disclosure regime, which took effect last year.
Viewed in this context, the new GAAR is part of a fundamental shift in the CRA’s approach to tax avoidance, said Florence Marino, vice-president of tax and estate planning with Tompkins Insurance in Toronto.
“In the old days, you tried a tax position and if the CRA had an audit and found you, then they might assert the GAAR,” Marino said. “Now you’ve got this combination of measures that are basically creating a nice lead-generation tool for the CRA to audit.”
However, Marino said, advisors can take consolation from a series of statements issued by the CRA’s Income Tax Rulings Directorate, which clarified positions on the application of the new GAAR to a series of common transactions:
- The first position statement, issued Feb. 28, confirmed none of C-59’s amendments to the GAAR would change the conclusions found in Information Circular 88-2, a CRA guidance document issued when the GAAR was introduced in 1988. The circular covered the GAAR’s applicability to basic tax planning techniques, such as estate freezes and butterfly transactions. “Any change of position would be applicable on a prospective basis only,” the guidance added.
- A second statement, issued Feb. 29, dealt with post-mortem pipeline transactions used to preserve the capital gain arising on the death of a shareholder, while limiting double taxation on the subsequent distribution of a private corporation owned by the shareholder at their death. The guidance document confirmed such a transaction was generally not considered misuse under either the old or new GAAR.
- A third statement, issued April 29, was prompted by the federal government’s decision to boost the capital gains inclusion rate from half to two-thirds as of June 25. The CRA said transactions undertaken purely to crystallize gains ahead of the June 25 deadline would generally not be considered subject to the GAAR.
“These things are nice to hear, but how much they are going to provide protection is a function of how identical or almost identical your particular transaction is, which is not always so simple,” Marino added.
Hegedus said tax advisors will need to wait for more substantial guidance in the form of real-world application of the new GAAR.
“It’s going to take some time to figure out what approach the CRA is taking,” he said. “The assessments will take years to get through and it will take even longer to get new rulings from the courts.”
“We could be decades away from the Supreme Court of Canada weighing in on a particular transaction,” Oakey added. “Which means we’ve got to be really diligent right now.”