Advisors could be caught in CRA’s expanded mandatory disclosure net

The Trudeau government unveiled a sweeping update to the Income Tax Act’s (ITA) mandatory disclosure regime in February 2022, saying the existing rules were “not sufficiently robust” and complaining about a lack of “timely, comprehensive and relevant information on aggressive tax-planning strategies.”

Currently, avoidance transactions — defined as having a tax benefit as their primary purpose — need to be reported to the CRA only when two of the following three hallmarks are present: advisors or promoters are engaged on a contingent-fee arrangement; advisors or promoters receive confidentiality protection regarding the transaction; and contractual protection is provided to the taxpayer or other parties in the event a tax benefit is challenged or ultimately fails to materialize.

However, under draft legislation released in February, a tax benefit would only have to be one of the main purposes of the transaction, and just one of the hallmarks would need to be present for the transaction to be reportable.

The new rules will place the onus on every advisor or promoter involved in a reportable transaction or series of transactions to make their own, separate disclosure to the CRA within 45 days rather than relying on a single report from the taxpayer.

“It’s a really big net, and you can see how most financial planners could pretty easily fall in,” said Mark Jadd, chairman of the Canadian tax group with Dentons Canada LLP.

Even if advisors and planners do not directly advise taxpayers regarding the creation and implementation of a reportable transaction, Jadd said, they could still be caught under the disclosure duties owed by those who promote or sell arrangements or schemes related to the transaction.

Despite significantly lowering the threshold for reportable transactions, Toronto tax lawyer David Rotfleisch said the new rules are not a huge departure from the norm. Rotfleisch instead sees the federal government’s proposals as the natural next step in the evolution of Canada’s tax system.

That evolution began with the introduction of the general anti-avoidance rule into the ITA in 1988 and continued with the arrival of the reportable transaction regime a decade ago. Over that period, Rotfleisch said, the onus for identifying avoidance transactions shifted: from the CRA, to detect them via audits, to taxpayers, to flag them in advance.

“The changes proposed in the last budget are really just a fine-tuning of the existing rules,” Rotfleisch said.

Still, the CRA could get much more than it bargained for thanks to the scattershot nature of the proposals.

“The lowering of the test to obtain a ‘tax benefit’ instead of an ‘avoidance transaction’ is extremely problematic,” Rotfleisch said. “Almost any tax-planning transaction can be characterized as providing a tax benefit. In my view, this is far too broad a reporting regime.”

The government also plans to create a new category of “notifiable transactions” requiring reporting by advisors and promoters involved in transactions identical or substantially similar to ones the CRA has previously identified as potentially abusive.

The notifiable list is expected to grow, but for now, it contains six types of transactions, including the manipulation of Canadian-controlled private corporation status to avoid anti-deferral rules applying to investment income; loss-straddle transactions created using a partnership; and avoidance of the 21-year deemed disposition for trust property.

Bruce Ball, vice-president of taxation with CPA Canada, said he understands why the federal government wishes to gather more information on aggressive tax-planning strategies. But he fears the CRA will be overwhelmed by the less-concerning transactions captured by the new rules.

For example, Ball said, straightforward merger-and-acquisition deals could trigger disclosure obligations because they often involve an element of tax planning. So could representations and warranties regarding taxes owing and potential reassessments. In addition, certain types of estate freezes could be considered reportable under the rules as drafted.

“We don’t think it’s helpful to the CRA to be getting lots of reports, and a good percentage of them dealing with routine transactions that shouldn’t be controversial,” Ball said. “If a transaction is not something the government really needs to know about, then it creates inefficiencies for the CRA and taxpayers.”

In other cases, Jadd said, the planned rules appear to require that advisors and promoters report transactions they may not know about — or that didn’t exist at the time they acted — depending on the nature and timing of subsequent transactions in the series.

“There’s no real due-diligence defence under the disclosure rules,” Jadd said.

In May, during a round-table discussion with members of the Conference for Advanced Life Underwriting, the CRA declined to offer any comfort on this point to financial advisors and other professionals who operate adjacent to tax planners without engaging directly in tax planning for clients.

The CRA was presented with a scenario in which a financial planner sold a generally available financial product to a client and received a sales commission from the issuer. The client’s tax advisor later combined that product with other strategies to obtain a tax benefit without the planner’s knowledge.

The agency refused to excuse the planner’s failure to disclose a reportable transaction.

As part of a joint submission to Finance Canada in April, CPA Canada and the Canadian Bar Association recommended the government include a “materiality” test to reduce the scope of reportable transactions and exclude minor transactions in which only a small tax benefit is gained.

The two organizations also asked Finance to draft a due-diligence rule for reportable transactions to match the one that exists for notifiable transactions, exempting from penalties advisors who exercised the required level of care and diligence despite their failure to report after inadvertently or unknowingly triggering their reporting obligations.

However, there were no major changes to the revised draft legislation Finance released in August.

Although the newer version pushed back the date on which the rules will take effect to the beginning of the 2023 tax year, other amendments were largely cosmetic. They provide exemptions from reporting obligations for clerical and secretarial staff involved in transactions and a mechanism through which employers and partnerships can file reports on behalf of their employees and partners.

In a statement to Investment Executive, Finance Canada spokesperson Caroline Thériault said the government is still reviewing submissions following the closure of the consultation period on Sept. 30.

“The Government of Canada is committed to enhancing the mandatory disclosure rules to facilitate early access to timely, comprehensive and relevant information on aggressive tax-planning strategies,” Thériault added.

In the meantime, anyone who might be considered an advisor or promoter under the proposed rules should review their billing practices and develop a system for identifying potentially reportable transactions, said Lesley Kim, a partner and tax lawyer with Gowling WLG in Calgary.

“At the end of the day, the penalties are so high that if reporting is necessary, you need to know,” Kim said, noting that the maximum fine could rise to $110,000 for late filing, in addition to 100% of the fees charged on the transaction. “Now is the time to prepare,” she added.

While advisors recommending aggressive tax structure products are the most likely to have reporting obligations under the new rules, Rotfleisch said, a lawyer can help clear up any confusion: “Financial advisors who are carrying out any type of tax planning need to obtain a tax opinion as to whether or not the proposed transaction is reportable.”

Jadd said he expects financial advisors who are comparatively tangential to tax-planning transactions to become more active in their communications with clients and their other professional advisors because of the proposals.

“If you’re making commission off a plan, I think it’s incumbent on the person to know what they’re selling,” he said. “And if you don’t know what the underlying transaction is, then you have to get assurances that it’s not a reportable transaction.”