“Changing of the GAAR”: A Background on the General Anti-Avoidance Rule, and Canada’s Attempt to Expand its Tax Power in the 2022 Budget
On April 7, 2022, the Minister of Finance, Chrystia Freeland, delivered Canada’s 2022 budget (the “Budget”).[1]
The Budget purports to introduce several new financial and taxation regimes, as well as enhance several existing mechanisms. One of the existing taxation mechanisms proposed to be amended is the General Anti-Avoidance Rule (the “GAAR”). The Government initially indicated they would be amending the GAAR in the 2021 Budget. The 2022 Budget now provides some additional detail, though we are still waiting for the actual legislation.
Background on the GAAR
By way of background, the GAAR is described in section 245 of Canada’s Income Tax Act.[2] Its purpose is to prevent abusive tax avoidance transactions or arrangements. At the same time, it is not intended to interfere with legitimate commercial and family transactions.
Put more simply, the GAAR is a tool which can be used by the Canada Revenue Agency (the “CRA”) to deny certain tax transactions where the circumstances are appropriate. For almost any tax planning then, one should consider the potential application of the GAAR, unless a specific anti-avoidance rule applies to a transaction.
That being said, how does one actually know if the GAAR applies to their tax transaction?
This issue was discussed in detail by the Supreme Court of Canada (the “SCC”) in Canada Trustco Mortgage Co v R.[3] In brief, for the GAAR to apply to deny a tax transaction, a three-step test must be met:
- Is there a “tax benefit”?
- Is there an “avoidance transaction” (either alone or as part of a series of transactions)?
- Did the transaction result in a “misuse” of the provision or “abuse” of the Income Tax Act as a whole?[4]
If these steps are satisfied, then s. 245(2) gives the CRA and the court the ability to deny a tax benefit, and provide other tax consequences that are “reasonable in the circumstances”. Examples of other tax consequences include disallowing the tax benefit, allocating the tax benefit to another person, or even re-characterizing the nature of the benefit (for example, re-characterizing one’s business gain to a capital gain, thereby introducing further tax repercussions).
Of course, satisfying the three-step test will depend on the nuances of a particular tax transaction and the facts at play.
Moreover, it is not always definitive that a beneficial tax transaction will trigger the GAAR. One merely needs to examine the case law to see that various beneficial tax transactions have yielded different outcomes on the GAAR even applying. For example, in the recent case of Canada v Alta Energy Luxembourg SARL,[5] the SCC held that the GAAR could not be applied against a company who sold shares and realized a capital gain in excess of $380 million, and then used a tax-advantageous treaty between Canada and Luxembourg to not have to pay any taxes on the $380 million gain.
Sometimes the CRA will specifically indicate in their publications that they will or will not try to apply GAAR to a specific transaction. However, in many cases the CRA has not commented. As a result, taxpayers are often forced to accept the risk that the CRA could attempt to apply the GAAR several years later when they have to decide with particular tax planning transactions.
The Budget’s Change to the GAAR
Turning back to the recent Budget references to the GAAR, the Federal Government proposed to expand the scope of the GAAR by amending the Income Tax Act, to “provide that the GAAR can apply to transactions that affect tax attributes that have not yet been used to reduce taxes.”
Simply put, there appears to be an attempt by the Federal Government to have the GAAR apply to transactions which are to have possible tax benefits realized years down the road, beyond the year the tax attribute was created. In effect, the Budget is proposing to broaden the definition of a "tax benefit" (step one of the three-part test from Canada Trustco) to include a reduction, increase, or preservation of an amount that could at a future time be relevant in calculating amounts owing under the Income Tax Act and other relevant legislation.
This proposal is likely in response to 1245989 Alberta Ltd v Canada (Attorney General).[6] In Wild, an individual used his “lifetime capital gains exemption” to execute transactions that increased paid-up capital and the adjusted cost base of shares in a tax-free manner. At the Federal Court of Appeal, it was found that steps taken in the current tax year to create a tax attribute which could provide a possible tax benefit in the future are not sufficient to assess the GAAR in the year that a tax attribute is created. In other words, it was held that, for there to be a “tax benefit” for the purposes of applying the GAAR to a particular year, the tax benefit must be realized in the same year.
However, it now appears that the Federal Government is hoping to crack down on this “same year” technicality in the Budget, by broadening what qualifies a “tax benefit” so as to include future years. Notwithstanding, the Budget clarifies that any CRA determinations made prior to “Budget Day” remain binding, and that these new measures would apply to determinations issued on or after Budget Day. It will be interesting to see how the Budget’s proposal on the GAAR unfolds, and whether we see an expansion of the first step of the three-step test. If a “tax benefit” is to apply to transactions that affect tax attributes which have yet to be realized, this will expand the risk of GAAR applying to tax planning as of 2022.
Practically, this may impact some of the actual tax planning undertaken. Tax practitioners will sometimes structure transactions to defer realizing the tax benefit until later years, to reduce the risk of GAAR applying. These proposed changes may therefore result in plans either no longer proceeding or no longer deferring the tax benefits, since such steps may no longer have the same effect of reducing GAAR risk.
Clients concerned with the proposed changes are encouraged to stay up to date with the Budget’s implementation. MaryAnne Loney or Michelle Fong can provide legal advice to individuals as it relates to these proposed changes, and can also assist with tax planning or advising with respect to the legal consequences of any tax planning undertaken.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.