Income Tax Act’s new anti-avoidance provisions

If the federal government decides to crack down on “aggressive” tax avoidance transactions, does it signal a sea change for advisors or is it really much ado about nothing?

In these tough economic times, governments everywhere are struggling to balance their budgets in the face of declining revenues. They have few options to boost revenues: increase taxes or increase scrutiny of perceived aggressive tax planning. In Canada, the federal government is seriously considering the latter.

In draft legislation released recently, proposed section 237.3 of the Income Tax Act contains reporting requirements with respect to certain perceived aggressive tax avoidance transactions that are entered into after 2010.

Generally, this new provision will oblige certain persons to report avoidance transactions or series of transactions if the transactions include two of three “hallmarks” provided in the definition of “reportable transaction” in subsection 237.3(1). These hallmarks — confidential protection hallmark, contractual hallmark and fee hallmark — are essentially identifiable circumstances that tend to be present in the context of tax avoidance transactions, with guidance provided by the vast amount of litigation surrounding the general anti-avoidance rule (GAAR) contained in Section 245 of the Act. 

The new provision would impose a reporting requirement on the particular person for whom a tax benefit could arise from an avoidance transaction or series of transactions. It aims to catch those who enter into an avoidance transaction for the benefit of a particular person as well as any “advisor” or “promoter” who is entitled to a fee in circumstances described in the definition of reportable transaction.

Clients and advisors alike must file a full and accurate information return in respect of each reportable transaction. To allay the concerns of vulnerable parties, the Department of Finance has stated that this is merely an administrative obligation and would not constitute an admission that the transaction violates the GAAR. Often though, taxpayers who are facing a GAAR audit will concede that the transaction was an avoidance transaction but that there was no “misuse and abuse” of the provisions, thereby availing themselves. New section 237.3, however, will also impose increased reporting obligations. These, critics say, are far too broad and pervasive.

The failure to report one of these transactions would allow the Canada Revenue Agency (CRA) to impose a late-filing penalty on the person or persons who failed to satisfy the requirements and redetermine the tax consequences of any person for whom a tax benefit could result from the undisclosed reportable transaction.

Failing to satisfy these reporting obligations will leave parties in a precarious position: they may be jointly and severally, or solitarily, liable for the penalty. In other words, the CRA may pursue an obligation against any one party to the transaction as if that party was fully liable. It would then become the responsibility of that party to find the other parties and sort out their respective proportions of liability and payment. Subsection 237.3(11) of the proposed provision does offer a due-diligence defence for advisors and promoters.

The due-diligence defence in the draft proposal is very similar to other due-diligence defences currently contained in the Act; it all comes down to the notion of “reasonableness.” A person may avoid prosecution if he or she has made reasonable efforts to determine whether a transaction is a reportable transaction, whether he or she is subject to an information reporting requirement in respect of the reportable transaction, and what information would have to be provided to the CRA. This assessment is very contextual, with reasonableness placed on a spectrum and assessed according to the specific facts and circumstances of each case.

The proposed rules are causing some controversy. Some tax professionals believe that their impact will be minimal, while others see a sea change whereby advisors will be hesitant to implement tax planning for what are currently everyday commercial transactions and are not abusive. The truth probably lies somewhere in between.

Like the GAAR provisions, these proposed provisions are very broadly phrased, which could make it difficult to determine exactly when somebody has violated them. This leaves many informed commentators with the impression that these rules may do little more than generate unnecessary paperwork and filings for everyday commercial transactions or arrangements that are perfectly permissible and within acceptable parameters. 

It is interesting to note that subsection 237.3(14) would expressly exclude transactions involving the acquisition of a tax shelter or the issuance of a flow-through share from being a reportable transaction. Perhaps Finance should consider enhancing the existing tax shelter reporting obligations pertaining to particular transactions. This would achieve the objective of greater clarity in certain perceived “hot beds” of avoidance, instead of increasing the uncertainty around the already-curious GAAR provisions.

Greer Jacks is updating jurisprudence in EverGreen Explanatory, an online research library of assistance to tax and financial professionals in working with their clients.