Amendments to the General Anti-Avoidance Rule – subtle changes not to be ignored

The April 7, 2022 federal budget contained proposals to amend the General Anti-Avoidance Rule (the “GAAR”) in order to expand the application to situations in which a tax attribute has been created, preserved or increased, but has not yet been realized.1 Proposed amendments to the Income Tax Act (Canada) (the “Act”) to effect the budget measure were announced at the same time as part of a Notice of Ways and Means Motion.2

Background

As described in section 245 of the Act, the purpose of the GAAR is to prevent abusive tax avoidance transactions or arrangements. It is not intended to alter or interfere with legitimate commercial transactions.

Under current legislation and pursuant to guidance set out by the Supreme Court of Canada in the Canada Trustco case3, for the GAAR to deny a tax transaction, a three-step test must affirmatively be met, in the order listed:

1. Is there a tax benefit?
2. Is the transaction (or series of transactions) an avoidance transaction?
3. Is there an abuse of the tax provisions relied upon to achieve the benefit or an abuse of the Act as a whole?

If the GAAR applies, the “tax consequences” to the taxpayer will be determined as is reasonable in the circumstances to deny the tax benefit. In connection with determining tax consequences upon application of the GAAR to a particular transaction, the Canada Revenue Agency (CRA) may determine the amount of any tax attribute by issuing a notice of determination pursuant to subsection 152(1.11).

In the context of creating, preserving or increasing a tax attribute, and whether there is a tax benefit, the Wild case4 provided clarity as follows:

In Wild, an individual used his capital gains exemption to execute transactions that increased paid-up capital (PUC) and the adjusted cost base (ACB) of shares in a tax-free manner. However, the individual did not immediately realize the benefit of the increased PUC, and instead retained the PUC for future tax planning purposes. The minister reassessed the taxpayer under the GAAR to decrease the PUC of the shares. The taxpayer’s appeal from the reassessment was dismissed by the Tax Court of Canada but allowed by the Federal Court of Appeal (FCA) through a reversal of the Tax Court’s decision. The FCA held that while the reorganization had changed the tax attributes of the shares, creating the potential for a tax-free distribution, that potential had not yet been realized and the Act had not, to date, been misused or abused. Although the PUC of the shares had been increased, the increase in and of itself, without a tax-free distribution, did not constitute a tax benefit for purposes of the GAAR.

The FCA ruled that the increase in a tax attribute that has not yet been realized is not considered a tax benefit for the purpose of an assessment under the GAAR.  This position has been reaffirmed in subsequent court cases such as Rogers Enterprises (2015) Inc5 and The Gladwin Realty Corporation.6

According to the government, the above court decisions run counter to the policy underlying the GAAR, reducing certainty for taxpayers and the CRA as they could have to wait several additional years to confirm any tax consequences of a transaction. The proposed legislative changes to the GAAR are in response to Wild and the subsequent cases mentioned above.

Proposed legislative changes – provisions

Where the GAAR applies to a transaction, the Act contains a set of rules intended to allow the CRA to determine the amount of a tax attribute relevant for the purposes of computing tax. This is done through a notice of determination under subsection 152(1.11), which, like a notice of assessment, is subject to rights of objection and appeal. The objective of these rules is that when these determined amounts become relevant to the future computation of tax, such determinations are to be binding on the taxpayer and the CRA.7

However, the complication with the last statement above is that the CRA cannot make a determination of a tax attribute relevant to the future computation of tax if a tax benefit, as defined in subsection 245(1) of the Act, does not exist (per the court case conclusions referenced above). That is, the CRA is unable to determine the tax attribute in real-time and is required to wait for a transaction to transpire in which the tax attribute is accessed/utilized, and the tax benefit is crystallized – so to speak.

In response, effective April 7, 2022, the Department of Finance has proposed amendments to the definitions of “tax benefit”8 and “tax consequences”9 in subsection 245(1), and an amendment to subsection 152(1.11)10 (determination under subsection 245(2)) of the Act.

Proposed legislation now permits real-time adjustments to tax attributes that could be relevant for purposes of computing tax at a subsequent time (as opposed to having to wait for the tax attribute to be utilized in the future via taxable transaction.)

Under the current legislation, the CRA may only issue an assessment under the GAAR in the year a tax attribute, created by an abusive avoidance transaction, is realized. For example, in Wild it appears the CRA could only recharacterize a return of PUC as a taxable dividend in the year the return of PUC is undertaken.  Under the proposed legislation, the CRA can apply the GAAR in the year the PUC is created and reduce the PUC of the shares in question to their pre-reorganization amount (i.e., a reduction of the tax attribute).

Proposed legislative changes – retroactive application

Application of the proposed legislative changes is both prospective and retrospective. The changes apply to any transactions that occur on or after April 7, 2022. The changes can also apply to transactions that occurred before April 7, 2022, if a notice of determination under 152(1.11) is issued after April 7, 2022. 

For past transactions that created or increased a tax attribute, which has not yet been realized, there is a concern an assessment under the GAAR may be issued on or any time after April 7, 2022 and apply to redetermine the tax attribute. For example, transactions following a Triad Gestco-type of planning are subject to this risk.11 Tax attributes created under this type of planning may be at risk of a determination under the GAAR on or after April 7, 2022 even if the attribute has not been realized. 

Below is an example of how proposed changes to the GAAR may apply to a transaction completed in the past.

• In 2004, Holdco implemented a reorganization resulting in the establishment of Subco, to which it sold, on a taxable basis, substantial land holdings. 
• The cost of the land to Subco was increased from $2 million (Holdco’s cost) to $10 million as a result of the sale.
• Holdco undertook other related transactions to shelter the capital gain realized on the sale of the land to Subco.
• Holdco, in respect of its 2004 taxation year, fully complied with income tax compliance and reporting requirements. No tax was paid in respect of the capital gain realized on the sale of land to Subco.
• Unrelated taxpayers had implemented similar transactions as Holdco and Subco, which in later years were subject to the GAAR.
• Holdco’s and Subco’s 2004 taxation year is statute-barred.
• In 2021, Subco sells 50 per cent of the land holdings, realizing a capital gain equal to the proceeds received less a 50 per cent of the bumped up cost resulting from the 2004 transaction. Subco properly reports the capital gain for tax purposes.
• The remaining 50 per cent of the land holdings with the unused portion of the bumped up cost remains a Subco asset.
• In 2023, Subco is subject to a CRA audit in which the CRA requests information supporting the cost of the land disposed of in 2021.
• Subco discloses the historical transactions to the CRA, supporting the cost base of the land disposed of.

Prior to the proposed amendments referenced above, it appears the CRA could apply the GAAR and determine the cost of the land disposed of in 2021, even though the 2004 transactions bumping up the cost of the land are statute-barred. However, it appears the CRA would not be able to determine (as a result of application of the GAAR) the remaining cost of the land Subco still holds. The CRA would have to wait until Subco sells the remaining land to determine the cost of the remaining land pursuant to an assessment under the GAAR. 

With the proposed changes, the CRA may issue a determination pursuant to the GAAR in respect of the cost of all the land at any time on or after April 7, 2022. There is no longer a need to wait until the remaining land is sold.

Conclusion

The proposed changes to the GAAR are intended to provide taxpayers and the CRA with more certainty, and may also increase efficiencies within the CRA. Under current legislation, the CRA does not have the ability to issue a determination under the GAAR until the tax attribute created/increased or preserved pursuant to an avoidance transaction is realized. This requires the CRA to track or monitor a particular taxpayer for numerous years until the tax attribute is realized, which is impractical and an inefficient use of CRA resources. With the amendments, the tax attribute can be determined by the CRA under the GAAR in real-time.

1. Such tax attributes can include the paid-up capital of shares, the cost or adjusted cost base of property, the undepreciated capital cost of depreciable property and the capital dividend account.
2. Contained in April 7, 2022 Notice of Ways and Means Motions.
3. Canada Trustco Mortgage Co v R, 2005 SCC 54
4. 1245989 Alberta Ltd v. Canada (Attorney General), 2018 FCA 114 (Wild)
5. Rogers Enterprises (2015) Inc v R, 2020 TCC92. In the Rogers case, the Tax Court of Canada noted the ambiguity of the tax benefit definition in subsection 245(1) of the Act and held that the words meant a refund of tax or a refund of another amount under the Act, confirming the tax benefit definition as it read at the time did not apply to an increased but unrealized tax attribute.
6. Gladwin Realty Corporation v Canada, 2020 FCA 142. In the Gladwin case, when assessing whether a tax benefit has been obtained, the court applied the same principle as in the Wild case. In the case of an increase in the capital dividend account, there would be no tax benefit for the purpose of assessing GAAR until a capital dividend is paid to a taxpayer capable of benefiting from the tax-free character of the capital dividend, such as an individual or non-connected corporation.
7. Taken from the 2022 federal budget document.
8. The proposed change to the definition of “tax benefit” in subsection 245(1) is to include the phrase “a reduction, increase or preservation of an amount that could at a subsequent time be relevant for the purpose of computing a reduction, avoidance or deferral of tax or other amount payable under the Act or an increase in a refund of tax or other amount under the Act”. The amended definition suggests a tax attribute no longer needs to be realized to be considered a tax benefit for the purpose of an assessment under the GAAR.
9. The proposed change to the definition of “tax consequences” in subsection 245(1) is to include the phrase “any amount that is or could at a subsequent time be, relevant for the purpose of computing an amount referred to in paragraph (a) or (b)”.  Paragraph (a) or (b) includes the amount of income, taxable income, taxable income earned in Canada,tax, or other amount payable by or refundable to, a person under the Act. The addition of the phrase “or could at a subsequent time be” to the definition of “tax consequences” means a tax attribute, such as paid-up capital or adjusted cost base, that has yet to be realized may be considered a tax consequence of a particular transaction.
10. There are also proposed changes to subsection 152(1.11). The addition of the phrase “or could at a subsequent time be” to paragraph (a) expands the scope of the notice of determination provisions in subsection 152(1.11) of the Act to permit the minister to determine any amount that could, at a subsequent time, be relevant for purposes of computing income or tax payable.
11. “Triad Gestco-type planning” refers to tax planning resulting in an increase in the cost or adjusted cost base of property by triggering capital gains and sheltering such gains with capital losses that were effectively manufactured or created through non-commercial means.