This article provides a general overview of the changes proposed in the 2021 Federal Budget with respect to the mandatory disclosure rules contained in the Income Tax Act, RSC 1985, c 1 (the "Tax Act"). These changes have the objective of improving the ability of the Canada Revenue Agency ("CRA") to respond to aggressive tax planning. The proposed changes include among other things:
(1) Changes to the reportable transaction rule under the Tax Act;
(2) Extension of the reassessment period for reportable transactions;
(3) Requirement to report notifiable transactions;
(4) Requirement for specified corporations to report uncertain tax treatment; and
(5) Penalties for non-compliance.
It is important that stakeholders, including taxpayers, advisors and promoters become familiar with the proposed changes as they undergo a public consultation process, together with a related review of draft legislation and sample notifiable transactions, which will likely be released in the coming weeks. Comments addressed to the Department of Finance as part of the public consultation process should be sent by September 3, 2021, which does not leave a lot of time for stakeholders to comment.
What is the impetus for these changes? The world has globalized and the existing system of territorial taxation is not as appropriate as it used to be. The Organisation for Economic Co-operation and Development ("OECD") is amongst other things a clearinghouse for international tax treaties and global tax issues. It has issued a report known as the Base Erosion and Profit Shifting Project, Action 12: Final Report (the "BEPS Action 12 Report") which attempts to deal with the issue of tax planning which shifts profits from one jurisdiction to another for the purpose of avoiding tax altogether by eliminating taxation or greatly reducing tax rates. Many of the 2021 Budget recommendations are based on the BEPS Action 12 Report.
1. Changes to the reportable transaction rule under the Tax Act
The Tax Act already contains rules that require certain transactions to be reported to the CRA. Under the current rules, a transaction is reportable if it is an ’’avoidance transaction’’ as defined under the General Anti-Avoidance Rule (“GAAR”) of the Tax Act and if it bears at least two of the following three generic hallmarks:
(1) A promoter or advisor is entitled to "contingent fees" that are either (a) attributable to the amount of the tax benefit from the transaction, (b) contingent upon the obtaining of a tax benefit from the transaction or (c) attributable to the number of taxpayers who participate in the transaction or who have been provided advice by the promoter or advisor in respect of the transaction;
(2) A promoter or advisor requires "confidential protection" in respect of the transaction; and
(3) The taxpayer receives "contractual protection" in respect of the transaction. The term "contractual protection" refers to any form of insurance other than standard professional liability insurance that protects against failure to achieve any tax benefit from the transaction or covers any expense, fee, tax, interest, penalty or similar amount incurred during a dispute in respect of a tax benefit from the transaction. It also refers to any form of undertaking provided by a promoter that provides assistance in the course of such dispute.
To improve the effectiveness of Canada’s mandatory disclosure rules and in accordance with the BEPS Action 12 Report, it is proposed that a transaction would have to be reported if at least one (instead of two under the current regime) of the above mentioned hallmarks is present. Also, it is proposed that the definition of “avoidance transaction’’ be amended so that a transaction would be considered an ’’avoidance transaction’’ if one of its main purposes is to obtain a tax benefit even if the primary purpose of the transaction is a non-tax purpose.
Under the current regime, a reportable transaction must be reported to the CRA on or before June 30 of the calendar year following the calendar year in which the transaction first became a reportable transaction. This is often too large a delay in effectively dealing with the particular transaction and avoiding the spread of similar transactions. It is proposed that taxpayers who enter into a reportable transaction or another person who enters into such transaction on their behalf would be required to report the transaction to the CRA within 45 days of the earlier of:
(1) the day the taxpayer or the person who acts on their behalf becomes contractually obligated to enter into the transaction; or
(2) the day the taxpayer or the person who acts on their behalf enters into the transaction.
Under the current rules, if more than one party is required to report a transaction, a report by any of the parties will satisfy the requirement. It is now proposed that promoters and advisors be required to report in addition to taxpayers within the same time limit subject to an exception to the reporting requirement to the extent that solicitor-client privilege applies. The thinking is that a taxpayer’s disclosure can be checked against a promoter’s disclosure to assess the completeness and accuracy of the disclosure. One would ordinarily think that the taxpayer and the promoter should be coordinating their disclosure in any event.
2. Extension of the reassessment period for reportable transactions
Currently, the CRA is required to perform an initial examination of the tax return filed by taxpayers to assess tax payable, if any, with all due dispatch. After this initial examination, the CRA has a ’’normal reassessment period’’, typically three or four years depending on the type of taxpayer, after which it is precluded from reassessing the taxpayer (i.e., reassessment of the taxation year becomes statute-barred).
It is proposed that the “normal reassessment period’’ in respect of a reportable transaction would begin only after the taxpayer has complied with the applicable reporting requirement. Consequently, if the taxpayer does not comply with the mandatory reporting requirement, the reassessment of the year in which that transaction has occurred would not become statute-barred.
3. A new requirement to report notifiable transactions
The BEPS Action 12 Report recommends developing a disclosure regime that includes a mixture of specific and generic hallmarks. The hallmarks described above in relation to the reportable transaction rule are considered ’’generic’’. As for the specific hallmarks, they target particular areas of concern and have the objective of allowing governments to quickly develop targeted and appropriate responses to them.
It is proposed to introduce a category of specific hallmarks known as "notifiable transactions" in order to provide the CRA in a timely manner with pertinent information. More specifically, it is proposed that the Minister of National Revenue be given the authority to designate, with the concurrence of the Minister of Finance, a transaction as a "notifiable transaction". Similar to the approach that has already been taken in the U.S., such transactions would include both transactions found to be abusive by the CRA and transactions identified as transactions of interest.
As proposed, the description of each "notifiable transaction" would set out the fact patterns or outcome that constitute the transaction and include examples in appropriate circumstances in order to allow taxpayers to comply with the disclosure rule. Sample descriptions of notifiable transactions are expected to be issued as part of the consultation regarding the proposed measures.
Similarly to the reportable transaction rules, it is proposed that taxpayers who enter into a notifiable transaction, or another person who enters into such transaction on their behalf, be required to report the transaction to the CRA within 45 days of the earlier of:
(1) the day the taxpayer or the person who acts on their behalf becomes contractually obligated to enter into the transaction; and
(2) the day the taxpayer or the person who acts on their behalf enters into the transaction.
Moreover, it is proposed that promoters and advisors be separately required to report within the same time limit a scheme that, if implemented, would be a notifiable transaction, subject to an exception to the reporting requirement to the extent that solicitor-client privilege applies.
4. Reporting of uncertain tax treatment
An "uncertain tax treatment" refers to a tax treatment that is used, or planned to be used, in an entity’s income tax filings and for which it is uncertain whether it will be accepted as being in accordance with tax law.
Currently, disclosing "uncertain tax treatment" is not mandatory in Canada. Drawing from the experience of foreign countries, namely the U.S., it is proposed to implement a reporting regime in Canada whereby specified corporate taxpayers would be required to report particular uncertain tax treatments to the CRA. More specifically, the reporting would be required where the following conditions are met:
(1) The corporation is required to file a Canadian return of income for the taxation year;
(2) The corporation has at least $ 50 million in assets at the end of the financial year that coincides with the taxation year;
(3) The corporation, or a related corporation, has audited financial statements prepared in accordance with IFRS or other country-specific GAAP relevant for domestic public companies (e.g., U.S. GAAP); and
(4) An uncertainty in respect of the corporation’s Canadian income tax for the taxation year is reflected in those audited financial statements (i.e. it is not probable that the taxation authority will accept an uncertain tax treatment, and thus it is probable that the corporation will receive or pay amounts relating to the uncertain tax treatment).
Generally, the requirement to report particular uncertain tax treatments would apply to Canadian public corporations, subject to the above mentioned asset threshold considering that the financial statements of public corporations always must be prepared in accordance with IFRS. As for private corporations, the same requirement would apply if a given corporation meets the asset threshold and if it, or a related corporation, has audited financial statements prepared in accordance with IFRS.
It is proposed that corporations required to report uncertain tax treatment would have to provide prescribed information. Such complementary information would include the quantum of taxes at issue, a concise description of the relevant facts, the tax treatment taken and whether the uncertainty relates to a permanent or temporary difference in tax.
The uncertain tax treatments would have to be reported at the same time as the reporting corporation’s Canadian income tax return is due.
5. Penalties for non-compliance
It is proposed that persons who enter into reportable or notifiable transactions, or for whom a tax benefit results from a reportable or notifiable transaction, would be liable to a penalty of $500 per week for each failure to report those transactions up to the greater of $25,000 and 25 percent of the tax benefit.
The proposed penalty for corporations having assets with a total carrying value of $50 million or more is higher. The penalty for such corporations is $2000 per week up to the greater of $100,000 and 25 percent of the tax benefit.
Moreover, a promoter or advisor who fails to report a reportable or notifiable transaction would be liable to a penalty equal to the total of:
(1) 100 percent of the fees charged by that person to a person from whom a tax benefit results;
(2) $10,000; and
(3) $1,000 for each day during which the failure to report continues, up to a maximum of $100,000.
As for corporations subject to the requirement to report uncertain tax treatments, the proposed penalty for failure to report each particular uncertain tax treatment would be in the amount of $2,000 per week, up to a maximum of $100,000.
Application date of the new rules
Where the amendments are to apply to taxation years, they will apply to taxation years that begin after 2021. Where the new rules are to apply to transactions, they will apply to transactions entered into on or after January 1, 2022. However penalties will not apply to transactions that occur prior to the date that the enacting legislation receives Royal Assent.
The parallel with recent disclosure rules adopted in Québec
We see a similarity between the proposals in the 2021 Federal Budget and the new Québec rules on mandatory disclosure of "specified transactions" which we have described in a previous article available here. Of course if remains to be seen how the proposals outlined in the 2021 Federal Budget will evolve as a result of the public consultation to be held in the upcoming months.
Nevertheless, there is a clear desire at both the Provincial and the Federal levels to strengthen the reporting obligations in the field of taxation. In this context, the role of a professional tax advisor will become all the more important. Tax planning is alive and as important as ever but somewhat more precarious. Where new measures are enacted by the government in order to strengthen the existing taxation regime, it is simply a call for professionals in the taxation field to develop new tax planning solutions which do not cross the line. By any means, it is a much more complicated world and like Covid-19 realities we must all accustom ourselves to the new paradigm.