With the royal assent of Bill C-47 on June 22, 2023, changes to Canada’s income tax mandatory disclosure rules are law, and the Canada Revenue Agency (CRA) has recently issued new guidance on these 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 require taxpayers and their advisors to disclose certain tax planning transactions when they occur, rather than through the normal tax compliance process.
The new rules also require some corporations to report uncertain tax treatments as part of the tax compliance process. Failure to comply can result in significant penalties and an extension of the normal reassessment period, both noteworthy consequences of non-compliance.
This article looks at the new rules and their impact on taxpayers and their advisors.
Reportable transaction rules
The newly legislated reportable transaction rules expand the definition of an avoidance transaction and require only one of three hallmarks to exist for the transaction or series of transactions to be reportable.
Specifically, under the new legislation, an avoidance transaction will occur when one of the main purposes of the transaction is to achieve a tax benefit, which is usually the case when tax planning is undertaken.
The three hallmarks are:
This hallmark can be met, with certain exceptions, when the fees paid to the tax advisor are:
a) based on the tax benefit the tax planning is achieving;
b) contingent on the success of the planning; or
c) based on the number of persons who are benefitting from the tax planning.
This hallmark can be met, with certain exceptions, when a taxpayer is required to keep the information about the tax planning confidential.
This hallmark can be met, with certain exceptions, when a tax advisor is protected contractually from the taxpayer taking action against the tax advisor if the tax planning strategy proves unsuccessful.
The new rules incorporate several specific relieving measures, including the following:
- Fees for preparing Scientific Research and Experimental Development (SR&ED) claims will not result in the fee hallmark being met, even if the fee is contingent on the success of the SR&ED claim. This exemption was added as the CRA already receives adequate reporting of SR&ED 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.
- On Nov. 2, 2023, the CRA updated its guidance and clarified that, in general, ordinary commercial practices will not contravene the contractual protection hallmark.
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.
These rules can also apply to transactions that “straddle” royal assent. For example, if a person contracted to enter into a reportable transaction on June 1, 2023, but did not enter the relevant transaction until June 30, the reporting obligation will apply, and the 90-day reporting period will begin on June 30, 2023. If a person enters into a series of transactions that straddle the date of royal assent, the reporting requirement will apply with the first reportable transaction entered into following the royal assent.
Notifiable transaction rules
The notifiable transaction rules are a new concept. Under these rules, the Minister of National Revenue has the authority to designate notifiable transactions, with the concurrence of the Minister of Finance, that are subject to new reporting requirements. Failure to comply with these reporting requests will result in significant penalties, as well as an extension of the normal reassessment period. Notifiable transactions will include both transactions that the CRA has found to be abusive, and transactions identified as transactions of interest (i.e., where more information is required to determine if a transaction is abusive).
The new rules apply to notifiable 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.
The following transactions and series of transactions were designated as notifiable transactions, effective Nov. 1, 2023:
- Straddle loss creation transactions using a partnership.
- Avoidance of deemed disposal 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 in Section 256.1 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 Income Tax Act rules that restrict the deductibility of interest expenses in certain situations).
In addition to these transactions, any transactions that are substantially similar to these transactions will be considered reportable designated transactions.
Penalties for failing to report reportable or notifiable transactions
Separate penalties apply to the taxpayer and advisor or promoter.
For taxpayers, the rules include a penalty of:
- $500 per week for each failure to report a reportable or notifiable transaction, up to the greater of $25,000 and 25% of the tax benefit; or
- for corporations with assets that have a total carrying value of $50 million or more, $2,000 per week, up to the greater of $100,000 and 25% of the tax benefit.
Disclosing uncertain tax treatments
Disclosure rules for reportable uncertain tax treatments are also a new concept. The CRA defines an uncertain tax treatment as a tax treatment used in an entity's income tax filings for which there is uncertainty over whether the tax treatment will be accepted as being in accordance with tax law. Under these rules, certain corporations will be required to report uncertain tax treatments to the CRA as part of the corporate tax return filing 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 non-resident corporations with a taxable presence in Canada.
- The corporation has at least $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 standards 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 Jan. 1, 2023. That means that for most companies, the year ending Dec. 31, 2023, is the first year the new reporting requirements apply.
For corporations subject to the requirement to report uncertain tax treatments, failure to report each particular uncertain tax treatment can lead to a penalty of $2,000 per week, up to a maximum of $100,000.
The CRA has a detailed explanation of the updated mandatory disclosure rules. To learn of further designations as they are made, see the CRA’s designated transactions web page.
Contact your BDO tax advisor for further guidance on navigating the new rules.
The information in this publication is current as of December 18, 2023.
This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.