Written By Jared Mackey, Wade Ritchie and Sophie Virji
The 2023 Canadian Federal Budget, released March 28, 2023 (Budget 2023), proposes significant amendments to expand the application of Canada's general anti-avoidance rule (GAAR). These proposals come after the federal government's August 11, 2022 consultation paper, titled Modernizing and Strengthening the General Anti-Avoidance Rule (the Consultation Paper), which discussed various issues the government identified with the existing GAAR and described a variety of approaches it was considering to address these issues. Budget 2023 proposes the following amendments to the GAAR:
- Introducing a preamble containing interpretive rules and statements of purpose with language more commonly seen in legislative explanatory notes.
- Reducing the threshold for an avoidance transaction from a "primary purpose" test to a "one of the main purposes" test.
- Introducing an economic substance rule applicable at the abusive tax avoidance stage of the GAAR analysis.
- Introducing a 25 percent penalty on the value of tax benefits resulting from transactions that are subject to the GAAR.
- Extending the normal reassessment period by three years for GAAR reassessments.
The government has invited the public to submit written comments on the proposed amendments by May 31, 2023, following which the government intends to publish revised legislative proposals and announce an application date.
New GAAR Preamble
Budget 2023 proposes to introduce a new preamble to the GAAR to help address interpretational issues and ensure the GAAR applies as intended. The proposed preamble states that the GAAR:
- applies to deny the tax benefit of avoidance transactions that result directly or indirectly either in a misuse of provisions of the Act (or other applicable tax enactments) or an abuse having regard to those provisions read as a whole, while allowing taxpayers to obtain tax benefits contemplated by the relevant provisions;
- strikes a balance between taxpayers' need for certainty in planning their affairs, and the government of Canada's responsibility to protect the tax base and the fairness of the tax system; and
- can apply regardless of whether a tax strategy is foreseen.
It is unusual to see an interpretive preamble in Canadian tax legislation but is not unheard of in Canadian legislation. The Interpretation Act (Canada) states that the preamble of an enactment shall be read as a part of the enactment intended to assist in explaining its object.
Lower Threshold for Avoidance Transactions
The GAAR can only apply to a transaction or series of transactions that gives rise to a tax benefit, if the transaction or a transaction that is part of the series is an "avoidance transaction". An avoidance transaction is generally a transaction that results, directly or indirectly, in a tax benefit, unless the transaction may reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain the tax benefit. Budget 2023 proposes to reduce the threshold for the "avoidance transaction" test from a "primary purpose" test to a "one of the main purposes" test. If one of the main purposes of a transaction is to obtain the relevant tax benefit, the threshold would be met.
Although it is not uncommon for taxpayers to admit the presence of an avoidance transaction in GAAR cases, the Consultation Paper observed that some taxpayers have successfully defeated GAAR reassessments on the basis of there being no avoidance transaction. As Canadian courts have held that taxpayers can have multiple main purposes, the lower threshold under the proposals may result in fewer taxpayers contesting this element of the GAAR.
New Economic Substance Test
Budget 2023 proposes a new provision to clarify that economic substance is a relevant consideration at the misuse or abuse stage of a GAAR analysis but does not go so far as to deem a lack of economic substance to be abusive. Instead, the proposed rule states that if an avoidance transaction "is significantly lacking in economic substance", that "tends to indicate" abusive tax avoidance. This proposed rule does not directly change the abusive tax avoidance test, which continues to require a determination of the object, spirit and purpose of the provisions at issue followed by an analysis of whether the avoidance transaction defeats or frustrates such object, spirit and purpose.
The proposed new economic substance provision lists the following non-exhaustive factors that "tend to" establish—depending on the particular circumstances—that a transaction or series of transactions is significantly lacking in economic substance:
- all or substantially all of the opportunity for gain or profit and risk of loss of the taxpayer—taken together with those of all non-arm's length taxpayers—remains unchanged, including because of a circular flow of funds, offsetting financial positions, or the timing between steps in the series;
- it is reasonable to conclude that, at the time the transaction was entered into, the expected value of the tax benefit exceeded the expected non-tax economic return (which excludes both the tax benefit and any tax advantages connected to another jurisdiction); and
- it is reasonable to conclude that the entire, or almost entire, purpose for undertaking or arranging the transaction or series was to obtain the tax benefit.
It is unclear how much this rule, if enacted, will change the weight a court gives to a lack of economic substance in a GAAR analysis. Canadian courts have been clear to not reduce GAAR to a "smell test", but the existence or absence of economic and commercial substance at times has influenced a court's abusive tax avoidance analysis. If the proposed rule is enacted, however, economic substance may become a point of greater focus in GAAR cases and something that taxpayers and advisors will need to consider before undertaking a transaction.
GAAR Penalties and an Extended Reassessment Period
To deter taxpayers from engaging in abusive tax planning, Budget 2023 proposes to introduce a penalty to transactions subject to the GAAR. A taxpayer whose transaction is subject to the GAAR may be liable for a penalty equal to 25 percent of the amount of the tax benefit resulting from the transaction. Under the proposals, taxpayers can avoid a penalty if they have disclosed the relevant transaction to the Canada Revenue Agency (the CRA), either as required by mandatory disclosure rules or on a voluntary basis. The penalty will also generally not apply where the relevant tax benefit involves a tax attribute that has not yet been used to reduce tax—for example, a transaction that increases the paid-up capital of shares.
Budget 2023 also proposes to extend the normal reassessment period by three years for GAAR cases, unless the transaction was disclosed to the CRA. Budget 2023 states that this extended reassessment period reflects the complexity of GAAR cases and the difficulties in detecting them.
If you have any questions about the new GAAR proposals, or other tax measures in Budget 2023, contact any member of the Bennett Jones Tax group.