New legislative proposals for the general anti-avoidance rule released

In the March 2023 Budget, the federal government announced changes to the general anti-avoidance rule, GAAR. These are the first substantial changes since the GAAR was introduced in 1988. These changes are in response to court cases where taxes assessed under GAAR have been challenged by the taxpayers.

The budget proposed that changes be made to the GAAR for the following items:

• changing the avoidance transaction standard;
• introducing an economic substance rule; and
• introducing a penalty, as well as ways to mitigate a penalty. 

The budget contained these general proposals, but on August 4, 2023, draft legislation was released to codify these proposals into law. 

The GAAR now includes a preamble to the provision, laying out that the GAAR applies to deny the tax benefit of avoidance transactions that result directly or indirectly either in a misuse of provisions of the income Tax Act, (the Act), or an abuse of those provisions read as a whole, while not preventing taxpayers from obtaining tax benefits contemplated by Parliament. The amendments in the preamble specify that the misuse or abuse applies equally to the provisions of the Income Tax Regulations, the Income Tax Application Rules, a tax treaty, or any other law that is relevant in computing tax or any other amount payable by or refundable to a person under the Act or in determining any amount that is relevant for the purposes of that computation.  

The new preamble also states that the GAAR is intended to strike a balance between the government of Canada’s responsibility to protect the tax base and the fairness of the tax system and taxpayers’ need for certainty in planning their affairs.

These changes codify the intention of the GAAR in a way that the government believes is consistent with the intention of Parliament when the GAAR was first established.

Change to the avoidance standard 

The main difference between the proposed avoidance standard and the current law is that the proposed law puts the emphasis on a tax benefit where one of the main reasons for the transaction is the tax benefit. The current law states that a tax benefit that would not be subject to GAAR if the transaction may reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain the tax benefit.

Under the new proposals, many more transactions will be considered subject to GAAR due to the “one of the main purposes” test. However, to be a transaction subject to GAAR, a tax benefit must also have resulted in misuse or abuse of the income tax law.

New economic substance rule

The change to include an economic substance rule may be the most significant proposed change, as it states that if an avoidance transaction is significantly lacking in economic substance, it is presumed that the transactions results in a misuse or abuse under the Act.

The new rules contain a list of non-exhaustive factors that establish that a transaction or series of transactions is significantly lacking in economic substance:

(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:

1. a circular flow of funds;
2. offsetting financial positions;
3. the timing between steps in a series, or
4. the use of an accommodation party.

(b) It is reasonable to conclude that, at the time the transaction or series was entered, the expected value of the tax benefit exceeded the expected non-tax economic return.

(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.

The explanatory notes emphasize that the language “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” significantly broadens transactions that could be caught under the new rules.

Penalty and mitigation of penalty by reporting transaction

The new proposals contain a penalty provision as noted in the 2023 budget documents. The penalty is 25% of the amount by which a person’s tax payable for a taxation year is increased because of the application of the GAAR.

This penalty is mitigated and reduced to nil if the transaction was reported to the CRA in accordance with recently enacted mandatory reporting rules.

The penalty and the mitigation will both apply to transactions that occur on or after January 1, 2024. 

If you have questions

The draft legislation and the accompanying notes clearly show the proposed changes will restrict certain tax planning, particularly between related groups of taxpayers.