On 9 August 2022 the Canadian government published a consultation paper on strengthening the general anti-avoidance rule (GAAR). Comments are invited by 30 September 2022.

The paper notes that the GAAR, which was first introduced in 1988, has been reasonably effective in preventing abusive tax avoidance. It was designed to combat tax avoidance transactions without affecting legitimate commercial or private transactions. The GAAR therefore had to balance the taxpayers’ need to have certainty in tax matters with the government’s need to protect the tax base.

The government has had success in a significant proportion of GAAR cases, and in addition to this many aggressive tax plans are not implemented due to the likelihood that the GAAR would apply. However, a number of decisions in tax cases and other developments have highlighted issues with the GAAR that need to be addressed.

A few recent Supreme Court decisions have looked at the application of the GAAR in the context of a tax treaty and in relation to treaty shopping. The government is analysing the relevance of the decisions, for example in situations where the new preamble and principal purpose test in the Multilateral Convention to Implement Tax Treaty Related BEPS Measures (MLI) applies.

Identifying the tax benefit

There is a concern that, despite its broad definition, a tax benefit has not been found in every appropriate case.

In a small number of cases the courts found that there was no tax benefit even though tax planning had taken place. The government considers that the concept of tax benefit is interpreted too narrowly. Although no specific changes are proposed in the paper, comments are invited on any changes to the definition of “tax benefit” to ensure appropriate application.

Clarifying the object, spirit and purpose of the law

In tax disputes the taxpayer would normally have the burden of refuting any factual assumptions made by the Canadian Revenue Agency (CRA), but case law has evolved to impose on the CRA the burden of establishing that the transactions frustrate the object, spirit and purpose of the law.

Under the legislation, a transaction that results directly or indirectly in a tax benefit and has been carried out primarily to obtain the tax benefit is subject to the GAAR if it may be reasonably considered that it would result in a misuse of the law or an abuse of the provisions of the Act read as a whole.

The courts expect the Crown to submit persuasive arguments on the object, spirit and purpose of provisions and have tended to give the taxpayer the benefit of the doubt where it is not certain that abusive tax avoidance is involved.

The government is considering addressing this by the inclusion of preambles and purpose statements in income tax legislation; greater emphasis on purpose statements in external guidance; greater emphasis on the provision on the abuse of the Act read as a whole; and the inclusion of an interpretive rule for assessing certainty, predictability and fairness. Also, the taxpayer could be required to demonstrate the reasonable conclusion that the tax benefit would be consistent with the object, spirit and purpose of the relevant provisions.

Economic substance

It is considered that the GAAR does not sufficiently consider the economic substance of transactions.

In the Canada Trustco case, the Supreme Court noted that economic substance is relevant only if, and to the extent that, the text of the law says that it is relevant. Consequently, the courts do not expressly apply an “economic substance” test when considering if an avoidance transaction represents abuse or misuse of a particular law.

The government therefore proposes to add an explicit economic substance rule to the GAAR. This will involve defining economic substance; integrating the economic substance rule into the GAAR analysis; and determining the appropriate consequences for a lack of economic substance.

Penalties

The government considers that the GAAR does not have a sufficient deterrent effect on abusive tax planning. Where transactions are found to be abusive, the GAAR only applies the reasonable tax consequences. Currently the economic downside to taxpayers may be limited to the professional fees for implementing the transactions and the interest on the unpaid tax.

The government is proposing to introduce a penalty based on a percentage of the tax benefit; to increase the interest rate on taxes in dispute under a GAAR assessment; and to extend the reassessment period for GAAR assessments.

Other

The consultation paper invites comments on any other issues arising from the application of the GAAR that have produced inappropriate outcomes; and on any other ways to modernise the GAAR.