Significant changes to GAAR may be on the horizon

Taxpayers should be aware of potential changes intended to strengthen Canada’s general anti-avoidance rule (GAAR)—a measure intended to prevent Canadian taxpayers (such as corporations, trusts, or individuals) from receiving tax benefits as a result of abusive tax planning.

These proposed changes to the Income Tax Act (the Act) introduced in Budget 2023 and included in Bill C-59 are a part of the federal government’s initiative to clarify and broaden the GAAR’s scope. If the proposals are enacted, an analysis of whether the GAAR applies will rely more on legislation, whereas currently, decisions are based on tests set out by the Supreme Court of Canada. This will make it easier for the Canada Revenue Agency (CRA) to successfully deny tax benefits under this rule.  

Bill C-59 includes notable changes to the economic substance rule from draft legislation introduced on August 4, 2023. If enacted, the expanded GAAR rule will apply to transactions occurring on or after January 1, 2024, except for the new preamble which is effective upon Royal Assent. However, the new GAAR penalty only applies to transactions occurring on or after January 1, 2024 or Royal Assent, whichever is later. 

Background 

Currently, the GAAR applies when the following conditions are present: 

• a tax benefit results from the transaction 
• the transaction is an avoidance transaction 
• the transaction results in a misuse or abuse of the provisions of the Act 

Where the GAAR applies, any tax benefit that arose from the transaction is denied. 

What are the expanded rules? 

The federal government proposed the following amendments to the GAAR: 

A preamble to help interpret the GAAR 

The preamble is proposed to address existing interpretative issues to help ensure the GAAR applies as intended. Specifically, the preamble aims to clarify the GAAR’s intention to: 

• deny a tax benefit resulting from an avoidance transaction that misuses or abuses provisions of the Act, while still allowing taxpayers to obtain legitimate tax benefits; and 
• strike a balance between a taxpayer’s need for certainty in planning their affairs, and the government’s responsibility to protect the tax base and ensure tax fairness. 

A lower threshold for the avoidance transaction purpose test

Under the proposed rules, if a taxpayer undertakes a transaction and it can reasonably be considered that “one of the main purposes” of the transaction is to obtain a tax benefit (directly or indirectly), it would be considered an avoidance transaction. In other words, even a transaction that’s undertaken primarily for bona fide purposes could still be considered an avoidance transaction if one of its main purposes is to obtain a tax benefit. 

This broadens the scope of the GAAR compared to the current rule, which states that a transaction is not considered an avoidance transaction if it was undertaken “primarily” for bona fide purposes, even if it results directly or indirectly in a tax benefit. As a result, the proposed GAAR could apply to more transactions and fewer taxpayers will be able to contest GAAR assessments.  

An economic substance rule  

Under the proposed rules in Bill C-59, a transaction or a series of transactions that is “significantly lacking economic substance” is an important consideration that tends to indicate that the transaction meets the “misuse or abuse” test (rather than being presumed to meet the test, under the previous draft legislation). The proposed rules outline factors that may establish that a transaction lacks economic substance, such as:  

• all or substantially all of the opportunity for gain or profit and risk of loss of the taxpayer remains unchanged 
• it’s reasonable to conclude that the expected value of the tax benefit exceeded the expected non-tax economic return 
• it’s reasonable to conclude that the entire, or almost entire, purpose for undertaking the transaction was to obtain the tax benefit 

This change significantly expands the scope of the GAAR and is intended to ensure that the courts consider economic substance when determining whether the GAAR should apply. If enacted, taxpayers will need to carefully assess the impact of the economic substance test when engaging in tax planning. 

A penalty for GAAR reassessments 

To discourage taxpayers from engaging in abusive tax planning, Finance has proposed a new penalty equal to 25% of the increase in taxes payable resulting from the application of the GAAR. If a taxpayer is also subject to gross negligence penalties on the same transaction, this penalty would be subtracted from the GAAR penalties to avoid duplicative fines. Currently, a taxpayer is only denied the tax benefit plus interest on any overdue tax, where GAAR applies.    

Under the proposals, the penalty wouldn’t apply to: 

• transactions previously disclosed to the CRA under the new mandatory disclosure rules on Form RC312 Reportable Transaction and Notifiable Transaction Information Return; 
• transactions (not subject to the new mandatory disclosure rules) previously disclosed to the CRA voluntarily on Form RC312, provided this form is filed by the taxpayer’s tax return filing deadline for the taxation year in which the transaction occurred (or up to a year late, which would extend the normal reassessment period by one year); and 
• transactions where it’s reasonable to conclude that the GAAR didn’t apply based on case law or CRA administrative guidance on “identical or almost identical” transactions (with Finance noting in the explanatory notes that the threshold to meet this test is high). 

An extended reassessment period 

The expanded GAAR extends the normal reassessment period for GAAR assessments by three years unless the transaction was previously disclosed to the CRA. The extended reassessment period is intended to grant the CRA more time to identify transactions subject to the GAAR, given their complexity. 

Takeaway 

Having a comprehensive understanding of the expanded GAAR is important because if enacted, taxpayers will need to consider these substantial changes—including the new GAAR reassessment penalty—before they carry out transactions that result in tax benefits. Contact your advisor or reach out to us here to learn more about these proposed changes and for help planning your business transactions. 

^Disclaimer 

^{The information contained herein is general in nature and is based on proposals that are subject to change. It is not, and should not be construed as, accounting, legal or tax advice or an opinion provided by Grant Thornton LLP to the reader. This material may not be applicable to, or suitable for, specific circumstances or needs and may require consideration of other factors not described herein.}