In June 2024, changes to the general anti-avoidance rule (GAAR) took effect. These changes strengthened the teeth of this tax anti-avoidance rule, expanding its scope and introducing a penalty for transactions that are found to breach the rule.
The GAAR is a general fallback rule which can apply to transactions which, although complying with the Income Tax Act, are contrary to the spirit of the Act and result in a misuse or abuse of its provisions.
An example of this would be where a transaction results in an outcome which was not intended by the Act, even though the transaction has not technically breached any of the Act’s provisions.
When it comes to reorganizations of corporations and personal estates, the GAAR is very significant. These types of reorganizations frequently involve several separate transactions that, when combined, can save or defer taxes, neither of which the CRA likes.
The CRA may use the GAAR as a backup to punish these “abusive” transactions if they believe that any of the transactions result in a misuse or abuse of the Act, especially if they have no other powers to prevent the saving or deferral of tax, but where they believe that an abuse of the Act has occurred.
One of the most significant changes to the GAAR rules is the change in the definition of what an “avoidance transaction” is – a transaction must be an avoidance transaction in order to be caught by the GAAR.
Previously, a transaction could avoid being caught by the GAAR if it could be shown that there were “bona fide purposes” to the transaction, other than the obtaining of a tax benefit, and that these purposes were the primary reason for entering into the transaction.
Therefore, if there were genuine business reasons for the transactions (for example creditor-proofing, restructuring, planning for the entrance or exit of shareholders, etc.), the fact that the transactions also resulted in a tax benefit was not usually enough for the transactions to be caught by the GAAR.
Now, as a result of the recent changes, a transaction can constitute an avoidance transaction where “one of the main purposes” of the transaction was to obtain a tax benefit.
This may seem like a subtle change in wording, but it significantly widens the net in terms of transactions that may be caught by the GAAR.
Under the new wording, even if there are bona fide non-tax purposes for entering into a transaction, if there is also a tax reason for entering into the transaction, the bona fide purposes are not enough to fall out of the GAAR net.
To add to this, the consequences of being caught by the GAAR are now far more penal.
Before the changes, the only real repercussion of being caught by the GAAR was that the “tax benefit” that the taxpayer achieved was denied.
Therefore, the taxpayer was essentially placed back in the same financial situation as if they had not entered into the avoidance transaction and obtained a tax benefit.
A financial penalty has been introduced for transactions caught by the GAAR.
This penalty is 25% of the extra tax charged if the GAAR is found to apply (i.e. 25% of the tax benefit that was achieved by the transaction before GAAR denied the benefit).
Even though these two changes are arguably the most important, there are a lot of other changes to the rules that need to be understood because they may also cause a transaction to now be subject to the GAAR.
There are also changes which may mitigate the increased scope of the GAAR. For example, the new penalty may not apply if the taxpayer voluntarily discloses the details of the transaction before the CRA becomes aware if it. This, of course, is what the CRA is hoping to achieve.
It will take many years for the full impact of these changes to become known. Transactions will be taken to court for a judicial analysis of the new GAAR rules and how, and if, they apply.
Until the full extent and range of the updated rules becomes clear, advisors and taxpayers must exercise caution when entering into transactions that result in a “tax benefit”, which includes tax savings, a tax deferral, and an increase to a tax refund, among other things.
For now, the CRA has started to release guidance in relation to situations where it thinks the new GAAR rules will and will not apply.
For example, the CRA have already suggested that common estate plans, such as estate freezes (see the March 2024 Tax Letter) may not be subject to the GAAR in certain circumstances.
For taxpayers entering into any tax planning, it is now more important than ever to work closely with your tax advisor to ensure that the new GAAR rules are considered.
Although the rules are complex, and their interpretation is still largely uncertain at this point, it is very important to try to understand the rules and anticipate how the courts may view any proposed transactions from a GAAR point of view.