The General Anti-Avoidance Rule: more changes coming in 2023
By Graham Haynes & Isaac McLellan
Introduction
The Canadian federal budget was unveiled on Tuesday, March 28, 2023 (“Budget 2023”)1 , and proposes significant changes to the General Anti-Avoidance Rule (the “GAAR”) in Canadian tax law under the Income Tax Act (Canada) (the “Act”). For background, the 2022 Canadian federal budget (“Budget 2022”) announced minor amendments and a coming consultation paper2 to consider further amendments to “modernize” the GAAR.
The promised consultation paper was published by the Department of Finance on August 9, 2022 (the “Consultation Paper”),3 and proposed approximately 12 significant changes to the GAAR,4 five of which have been adopted under Budget 2023:
1. The adoption of a preamble to the GAAR;
2. Lowering the threshold for the necessary finding of an avoidance transaction;
3. A new economic substance test;
4. A penalty tax for GAAR-offending transactions; and
5. Extending the normal reassessment period for GAAR challenges.
Below are detailed descriptions of these changes.
Proposed Changes
1. GAAR Preamble
The addition of a preamble to the GAAR to help address interpretive issues and ensure that the GAAR applies as the federal government intended. The proposed preamble states that the GAAR:
a) applies to deny the tax benefit of avoidance transactions that result directly or indirectly either in a misuse of provisions of the Act (or other applicable tax enactments) or an abuse having regard to those provisions read as a whole, while allowing taxpayers to obtain tax benefits contemplated by the relevant provisions;
b) strikes a balance between taxpayers’ need for certainty in planning their affairs, and the Government of Canada’s responsibility to protect the tax base and the fairness of the tax system; and
c) can apply regardless of whether a tax strategy is foreseen.
This preamble, per the Interpretation Act (Canada) states that the preamble of an enactment shall be read as part of the Act in explaining the object and purpose of the section in question.
2. Primary Purpose vs One of the Main Purposes
The threshold for the avoidance transaction test in the GAAR would be reduced from a “primary purpose” test to a “one of the main purposes” test. In the GAAR analysis, a transaction will only be subject to the GAAR if it is an avoidance transaction. An avoidance transaction is a transaction that is undertaken to result in a tax benefit, whether directly or indirectly, and it was undertaken for the primary purpose of obtaining a tax benefit. Under the proposed change, transactions that were undertaken with one of the main purposes being a tax benefit, rather than the primary purpose. This would in effect make a larger number of transactions subject to satisfying the avoidance transaction step under the GAAR.
3. Economic Substance Rule
A rule would be added to the GAAR so that it better meets its initial objective of requiring economic substance in addition to literal compliance with the words of the Act. The proposed amendments would provide that economic substance is to be considered at the ‘misuse or abuse’ stage of the GAAR analysis and that a lack of economic substance tends to indicate abusive tax avoidance. This proposed rule does not directly change the abusive tax avoidance test, which continues to require a determination of the object, spirit and purpose of the provisions at issue, followed by an analysis of whether the avoidance transaction defeats or frustrates such object, spirit, and purpose. The amendments would provide indicators for determining whether a transaction or series of transactions is lacking in economic substance, such as:
a) all, or substantially all, of the opportunity for gain or profit and risk of loss of the taxpayer – taken together with those of all non-arm’s length taxpayers – remains unchanged, including because of a circular flow of funds, offsetting financial positions, or the timing between steps in the series;
b) it is reasonable to conclude that, at the time the transaction was entered into, the expected value of the tax benefit exceeded the expected non-tax economic return (which excludes both the tax benefit and any tax advantages connected to another jurisdiction); and
c) it is reasonable to conclude that the entire, or almost entire, purpose for undertaking or arranging the transaction or series was to obtain the tax benefit.
4. GAAR Penalty
A penalty will be introduced for transactions subject to the GAAR. A taxpayer whose transaction is subject to the GAAR can be liable for a penalty equal to 25% of the tax benefit. This penalty can be avoided if the transaction was disclosed to the Canada Revenue Agency previously, whether by the mandatory disclosure rules or on a voluntary basis, or if the tax benefit involves a tax attribute that has been yet been used to reduce tax.
5. Extension to Normal Reassessment Period
A three-year extension to the normal reassessment period would be provided for GAAR assessments, unless the transaction had been disclosed to the Canada Revenue Agency.
The Federal Government has opened up a consultation period for stakeholders, practitioners, and other parties to submit their feedback on these proposed changes up until May 31, 2023.
This client update is provided for general information only and does not constitute legal advice. If you have any questions about the above, please contact the authors or a member of the Stewart McKelvey Tax Group.
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[1] Budget 2023 – Tax Measures: Supplementary Information (Government of Canada, 2023).
[2] For context, a public consultation regarding the “modernization” of the GAAR was first announced in the 2020 Fall Economic Statement, and the intention to complete such a consultation was reiterated in the 2021 Canadian federal budget before the consultation was finally announced in Budget 2022.
[3] Modernizing and Strengthening the General Anti-Avoidance Rule Consultation Paper (Government of Canada, 2022).
[4] For further information on the changes originally proposed in the Consultation, see P. Festeryga and G. Haynes, “GAAReimagined: Where Are We and How Did We Get Here?”, 2022 Atlantic Provinces Tax Conference Journal (Toronto: Canadian Tax Foundation, 2022).