General anti-avoidance rule amendments raise uncertainty and costs for clients: lawyer
Keith Hennel, chair of Dentons Canada LLP’s Edmonton tax group, says his team’s risk identification and mitigation responsibilities require them to proactively lead discussions with clients on significant new tax reforms rather than waiting for them to come to the firm with questions.
On June 20, the federal government enacted changes to the Income Tax Act as part of Bill C-59. These include significant adjustments to the general anti-avoidance rule (GAAR), which is intended to prevent transactions that are counter to the purposes of Canadian tax law.
“I don't think there's a lot of public visibility on the GAAR or the GAAR changes, so it's really on practitioners to raise these changes with their clients,” says Gergely Hegedus, a partner in Dentons’ tax group.
There are “five major changes,” he says.
Ottawa has altered the preamble that helps interpret the GAAR. According to an article by accounting firm Grant Thornton, the new preamble aims to clarify the GAAR’s intention to deny tax benefits resulting from a transaction misusing the Income Tax Act while allowing for legitimate tax benefits. The preamble also clarifies that the GAAR balances taxpayer certainty and the government’s responsibility to protect its tax base and promote fairness.
The GAAR also has a new economic substance test. If the transaction lacks this substance, that will indicate it’s a misuse or abuse of the Income Tax Act, says Hegedus. The factors Canada Revenue Agency will use to determine whether a transaction lacks economic substance include a low-profit opportunity and loss risk, a situation where the tax benefit is higher than the non-tax return, and where the entire purpose of the transaction is the tax benefit.
“There are specific things that the CRA will look at, such as whether there's a circular flow of funds between the parties,” says Hegedus. “If the funds are going between the parties so that the net effect is there's no real change, those kinds of things would indicate a lack of economic substance to the transaction.”
Ottawa has also broadened the definition of an “avoidance transaction.” Previously, GAAR would apply when “one of the main purposes of the transaction was to obtain a tax benefit,” he says. Now, all that is required is “one of the main purposes” of the transaction is to obtain a tax benefit. If that is the case, the GAAR will apply.
The new GAAR penalties are 25 percent of the amount of the increased tax owed after the GAAR is applied.
One of the main themes of the reforms is “uncertainty,” says Hennel.
“While taxes can be uncertain in the best of times, this just adds a lot more uncertainty into tax planning and transactions and whether or not the new GAAR will apply. That causes a lot of anxiety.”
Hennel and Hegedus advise clients to choose from three routes when considering a transaction for which the GAAR may apply. The first is an advanced tax ruling. If a party is concerned about a transaction, they can ask the CRA to opine on whether the GAAR will apply.
The second is to disclose the transaction ahead of time. When taxpayers do this, the GAAR penalty will not be applied.
The third option is to undertake the transaction and accept the risk.
“These changes and uncertainty add more cost to taxpayers in paying fees for advice,” says Hennel. “It's more important than ever for taxpayers undergoing complicated transactions to receive advice from professional advisors before undertaking a transaction.”
