Canada releases draft legislation for new mandatory disclosure tax rules
On February 4, 2022, the Canadian federal government released draft legislative proposals (“Proposals”) to expand the existing mandatory disclosure tax rules, which were announced with the 2021 federal budget and are designed to provide the Canada Revenue Agency (“CRA”) with information on potentially abusive tax avoidance transactions. The government invites the public to provide comments on the Proposals by April 5, 2022. If enacted as proposed, the Proposals would apply to transactions occurring in taxation years beginning after 2021.
Under the existing rules, a “reportable transaction” must be reported to the CRA.
A “reportable transaction” means a transaction that meets the following two conditions:
- The transaction is undertaken primarily to obtain a tax benefit.
- The transaction has two out of the following three “hallmarks” (which according to the government often indicate transactions that are more likely to be challenged by the CRA):
- Contingent fees. A promoter or advisor is entitled to contingent fees in respect of the transaction - e.g. based on the amount of the tax benefit.
- Confidential protection. A promoter or advisor obtains “confidential protection” in respect of the transaction - e.g. anything prohibiting disclosure of the transaction to anyone, including the CRA. Note that “confidential protection” does not arise from confidentiality obligations given by an advisor to his or her client (e.g. under solicitor-client privilege) or a provision in tax opinions limiting an advisor’s liability to his or her client and disclaiming liability to any third party.
- Contractual protection. A taxpayer (or certain other persons) obtains “contractual protection” in respect of the transaction - e.g. any form of insurance (other than standard professional liability insurance) or other protection (e.g. indemnity, compensation, or guarantee) designed to protect the taxpayer against a failure to achieve the tax benefit.
A reportable transaction must be reported to the CRA by filing an information return by June 30th of the calendar year following the year in which the transaction occurs. Generally speaking a return must be filed by the taxpayer seeking the tax benefit or a promoter or advisor entitled to contingent fees in respect of the transaction. By virtue of a relieving rule, if multiple parties are otherwise required to report the same transaction, only one of the parties is required to report the transaction.
The Proposals would expand the existing rules by:
- expanding the existing category of “reportable transactions” and accelerating the reporting deadlines;
- creating a new requirement to report “notifiable transactions”;
- creating a new requirement for certain corporations to report “uncertain tax treatments”;
- extending the normal reassessment period in cases of non-compliance; and
- expanding the penalties for non-compliance.
Expanded category of reportable transactions and accelerated reporting deadlines
The Proposals would expand the existing category of reportable transactions by only requiring:
- the transaction to have one out of the three hallmarks (instead of two); and
- one of the transaction’s main purposes to be to obtain a tax benefit (instead of the transaction’s primary purpose, which is a higher threshold).
As a positive development, especially considering the new requirement for only one hallmark, the Proposals would amend the definition of “contractual protection” to exclude certain types of contractual protections “offered in the context of normal commercial transactions to a wide market”, which is presumably intended to address the concern that, under the existing rules, certain types of representation and warranty insurance and transactional tax insurance could be considered “contractual protection” and therefore a hallmark.
A taxpayer, promoter, or advisor subject to these rules would be required to report the transaction to the CRA by filing the information return within 45 days of the earlier of the date the taxpayer becomes contractually obligated to enter, or actually enters, into the transaction. Further, the existing relieving rule applicable where multiple parties are required to report the same transaction would be eliminated such that all parties would be required to report the transaction.
New requirement to report notifiable transactions
Under the Proposals, the CRA would have the authority to designate (with the concurrence of the Minister of Finance) certain types of transactions as “notifiable transactions”, which would include transactions the CRA considers to be abusive or potentially abusive. This proposal is similar to the new mandatory disclosure rules in respect of “specified transactions” recently introduced in Quebec. For more information on the Quebec rules, please refer to our article available here.
The Proposals contain samples of notifiable transactions, which fall into the following six categories:
- Manipulating “Canadian-controlled private corporation” status to avoid anti-deferral rules.
- Straddle loss creation transactions using a partnership.
- Avoiding the 21-year deemed disposition rule for trusts.
- Manipulating bankrupt status to reduce debt forgiveness.
- Using the anti-avoidance rules designed to restrict tax attribute trading to avoid an acquisition of control of a corporation.
- Using back-to-back lending arrangements to avoid the thin capitalization rules or non-resident withholding tax.
The list of sample notifiable transactions is available here.
The Proposals state that a transaction designated as a notifiable transaction would be described in sufficient detail to enable taxpayers to identify the transaction and comply with the rules.
In addition to designated transactions, a transaction that is “substantially similar” to a designated transaction would be a notifiable transaction subject to disclosure. Under the proposed definition of “substantially similar”, two transactions would be substantially similar if they are expected to result in the same or similar tax consequences and are either factually similar or based on the same or similar tax strategy. Further, the government states that the substantially similar concept is to be “interpreted broadly in favour of disclosure”. As such the substantially similar concept significantly broadens the category of notifiable transactions and will likely introduce a considerable degree of uncertainty as to which transactions must be disclosed.
Like under the reportable transaction rules, a taxpayer who enters into a notifiable transaction (or a promoter or advisor who promotes or advises on a notifiable transaction, subject to an exception for solicitor-client privilege) would be required to report the transaction to the CRA by filing an information return within 45 days of the earlier of the date the taxpayer becomes contractually obligated to enter, or actually enters, into the transaction.
An information return for a notifiable transaction is expected to be required to:
- describe the expected tax consequences of the transaction;
- describe any contractual protection with respect to the transaction;
- describe any contingent fees with respect to the transaction;
- describe the transaction in sufficient detail to enable the CRA to understand it;
- identify the statutory provisions relied on for the expected tax treatment;
- identify (to the filer’s best knowledge) every person required to report the transaction; and
- provide all other required information.
New requirement for certain corporations to report uncertain tax treatments
Under the Proposals, a “reporting corporation” would be required to report a “reportable uncertain tax treatment” in respect of a taxation year.
A “reporting corporation” is a corporation that meets the following three conditions in respect of a year:
- The corporation is required to file a Canadian income tax return for the year.
- The corporation has at least $50 million in assets at the end of the year.
- The corporation has audited financial statements prepared in accordance with IFRS or other country-specific GAAP relevant for domestic public companies (e.g. US GAAP).
A “reportable uncertain tax treatment” is a treatment in respect of a transaction that the corporation uses or plans to use in an income tax return or information return in respect of which uncertainty is reflected in the corporation’s (or its consolidated group’s) audited financial statements for the year.
A corporation subject to these rules would be required to report the uncertain tax treatment at the same time as its Canadian income tax return is due (i.e. generally six months after the end of its taxation year). It is expected that the following information would be required to be reported:
- the relevant taxation year;
- the relevant facts;
- the relevant statutory provisions relied on;
- the differences between the corporation’s tax payable determined in accordance with its relevant financial statements and tax treatment, and whether those differences are temporary or permanent, involve a determination of value of property, and involve a computation of basis; and
- all other required information.
This is a significant development for public companies that are required to report their uncertain tax positions for audited financial statement purposes. Although the BP Canada Energy Company (2017 FCA 61) decision (“BP”) confirmed that the CRA may seek disclosure of a taxpayer’s tax audit working papers, including its analysis of reserves for uncertain tax positions (“UTPs”), the Proposals go a step further by requiring reporting corporations to not only make its tax working papers available during an audit, but also to provide the CRA with a roadmap to its UTPs. In BP, the Federal Court of Appeal expressed the concern that taxpayers may be less transparent with their financial auditors knowing that their UTPs may become routinely producible on a tax audit, which would ultimately be detrimental to investors. One may expect that similar concerns may arise with respect to the new requirement to report an uncertain tax treatment. In light of the Proposals, affected taxpayers may wish to review their UTPs carefully. Although the Proposals do not require the disclosure of information that is subject to solicitor-client privilege, the privilege only applies to confidential legal advice obtained by taxpayers and would generally not prevent the disclosure of factual information, legislative provisions, or issues that gave rise to an uncertain tax treatment.
Extended normal reassessment period
Under the Proposals, the normal reassessment period would not begin until the taxpayer has complied with the applicable reporting requirement (with respect to a reportable transaction, notifiable transaction, or uncertain tax treatment). As such, if a taxpayer does not comply with an applicable reporting requirement for a transaction for a taxation year, that year would effectively never become statute-barred and would therefore always be subject to reassessment.
A taxpayer that fails to comply with an applicable reporting requirement for a reportable transaction or notifiable transaction would be subject to penalties of up to the greater of:
- $25,000 (or $100,000, for a corporation with at least $50 million in assets); and
- 25 percent of the tax benefit.
A promoter or advisor that fails to comply with an applicable reporting requirement for a reportable transaction or notifiable transaction would be subject to penalties equal to the total of:
- 100 percent of the fees charged to the taxpayer;
- $10,000; and
- $1,000 for each day during which the failure continues, up to $100,000.
A corporation that fails to comply with an applicable reporting requirement for an uncertain tax treatment would be subject to penalties of $2,000 per week during which the failure continues, up to $100,000.
For more information on the Proposals, please refer to the government backgrounder available here, and draft legislative proposals and explanatory notes available here and here.
If you have any questions about these proposals, please contact any member of our National Tax Group.
This article provides only general information about legal issues and developments, and is not intended to provide specific legal advice. Please see our disclaimer for more details.