With the Royal Assent of Bill C-47 on June 22 2023, changes to Canada’s income tax mandatory disclosure rules are now law, and the Canada Revenue Agency (CRA) has issued guidance on the new rules. The mandatory disclosure rules expand the reportable transaction rules and introduce new reporting obligations for notifiable transactions and reportable uncertain tax treatments.
These changes will require taxpayers and their advisors to disclose certain tax planning transactions when they occur rather than through the normal tax compliance process.
There are also new rules that will require some corporations to report uncertain tax treatments as part of the tax compliance process. Failure to comply can result in significant penalties, as well as an extension of the normal reassessment period, both noteworthy consequences of not complying on a timely basis.
This article looks at the new rules and their impact on taxpayers and their advisors.
Reportable transaction rules
The revised reportable transaction rules expand the definition of an avoidance transaction, only require one of the three hallmarks or indicators of aggressive tax planning to exist for the transaction or series of transactions to be reportable but also include certain relieving measures.
Reportable transaction rules were first introduced into Canada’s Income Tax Act (ITA) in 2011. The purpose at the time was to provide the CRA with more information than it would otherwise receive on aggressive tax planning and to provide the information earlier. This information would likely only be received as part of the normal tax compliance process or during an audit.
The initial rules required reporting if there was an avoidance transaction (i.e., a transaction where the primary motivation is to achieve a tax benefit) as part of a series of transactions as defined under the General Anti-Avoidance Rules and two of three hallmarks of aggressive tax planning were present.
The three hallmarks were:
Fees: The amount of the fees paid to the tax advisor is based on the tax benefit the tax planning is achieving, is contingent on the success of the planning or is based on the number of persons who are benefitting from the tax planning.
Confidential protection: The taxpayer is required to keep the information about the tax planning confidential.
Contractual protection: The tax advisor is protected contractually from the taxpayer taking action against the tax advisor if the tax planning strategy proves unsuccessful.
In practice, the CRA experienced minimal reporting, as taxpayers and their advisors took steps to ensure that two of the three hallmarks were never present and, therefore, reporting was not required.
The newly effective rules will likely increase reporting to the CRA. The definition of an avoidance transaction has been modified for purposes of these rules. Now an avoidance transaction will occur when only one of the main purposes of the transaction is to achieve a tax benefit, which is usually the case when tax planning is undertaken and only one of the three hallmarks have to be met to require reporting.
The new rules incorporate a few relieving measures, including the following:
- Fees for preparing Scientific Research and Experimental Development (SRED) claims will not result in the fee hallmark being met, even if the fee is contingent on the success of the SRED claim. This exemption was added as the CRA already receives adequate reporting of SRED claims as part of the tax compliance process.
- Tax advisory fees that are not based specifically on time spent are known as value billing fees. Value billing will not result in the fee hallmark being met as long as the criteria on which the value billing is based are not:
- the value of tax benefits resulting from the transaction or series of transactions; or
- the number of persons who entered the transaction or series of transactions or who have been provided access to the advice or opinion.
- Standard representations, warranties and guarantees between third parties that are part of M&A transactions will not result in the contractual hallmark being met.
The new rules apply to reportable transactions entered after June 22 2023, the day on which the legislation received Royal Assent. Reporting must be done by filing an information return with the CRA within 90 days of the earlier of the day the taxpayer becomes contractually obligated to enter the transaction and the day the taxpayer enters the transaction.
Notifiable transactions rules
The notifiable transaction rules are a new concept in the ITA. Under these rules, the CRA can designate certain types of tax planning arrangements to be subject to new reporting requirements. Failure to comply with these reporting requests will be subject to significant penalties, as well as an extension of the normal reassessment period. In general, notifiable transactions will be specific types of transactions that the CRA has found to be abusive.
In 2022, the government released an initial list of six types of transactions that will be notifiable transactions, a list that will likely be expanded in the future. In addition to these transactions, reporting will be required for transactions that are substantially similar to any transactions on the list. The initial list of transactions includes:
- Manipulating Canadian Controlled Private Corporation (CCPC) status to avoid anti-deferral rules applicable to investment income earned by CCPCs.
- Straddle loss creation transactions using a partnership.
- Avoidance of deemed disposals of trust property (i.e., transactions to avoid the deemed disposition rules on property held on the 21st anniversary of a trust).
- Manipulation of bankrupt status to reduce a forgiven amount in respect of a commercial obligation.
- Reliance on certain purpose tests to avoid a deemed disposition of control (these rules are designed to constrain the trading of corporate tax attributes among arm’s length persons).
- Back-to-back arrangements (e.g., to avoid ITA rules that restrict the deductibility of interest expense in certain situations).
The new rules apply to notifiable transactions entered after 22 June 2023, the day on which the legislation received Royal Assent. Reporting must be done by filing an information return with the CRA within 90 days of the earlier of the day the taxpayer becomes contractually obligated to enter the transaction and the day the taxpayer enters the transaction. The Minister of National Revenue has yet to officially designate the list of notifiable transactions, so it would appear that the obligation to report these transactions will not arise until the list is released.
Disclosing uncertain tax positions
Disclosure rules for uncertain tax positions are also a new concept in the ITA. Under these rules, certain corporations will be required to report uncertain tax treatments to the CRA as part of the corporate tax return process.
Corporations must make these reports when the following conditions are fulfilled:
- The corporation is required to file a Canadian income tax return (T2) for the tax year. This would apply to Canadian-resident corporations and nonresident corporations with a taxable presence in Canada.
- The corporation has at least CAD 50 million in assets at the end of the financial year that coincides with the tax year. This threshold will apply to each individual corporation.
- The corporation, or a consolidated group of which the corporation is a member, has audited financial statements prepared in accordance with IFRS or other country-specific GAAP relevant for domestic public companies (e.g., U.S. GAAP).
- Uncertainty in respect of the corporation’s Canadian income tax for the tax year is reflected in those audited financial statements (e.g., the entity has concluded that it is not probable that the tax authorities will accept an uncertain tax treatment and thus, it is probable that the entity will receive or pay amounts relating to the uncertain tax treatment).
These new rules apply for tax years that begin on or after January 1 2023. That means that for most companies, the year ending December 31 2023 is the first year the new reporting requirements apply.