Concern Grows Over Canada’s Mission to Update Tax Avoidance Rule

Canada’s general anti-avoidance rule is at a critical point in its evolution. Since its introduction more than 30 years ago, it has been an effective tool for preventing abusive tax avoidance. The courts have developed a rigorous analytical framework to determine whether the GAAR should apply and have sought to balance the need for certainty in tax planning against the desire to combat abuse. The framework has largely achieved that balance, given that the Canadian tax authority has lost only 24 cases to date, despite having raised the application of the GAAR in more than 1,300 instances.

Notwithstanding this track record, the government is considering changes to the GAAR that could affect the way it would operate in the future. Any potential legislative changes will have to be considered in the context of a significant GAAR decision coming soon from the Supreme Court of Canada in Deans Knight Income Corp. v. Canada. As such, the tax landscape in Canada is on the brink of a new era.

Legislative Changes

The Canadian GAAR applies when three requirements are met:

There is a tax benefit.
There is an avoidance transaction (that is, a transaction undertaken primarily for tax purposes).
The avoidance transaction, or the series of transactions of which it is a part, must result in a misuse or abuse of the relevant tax provisions or the legislation as a whole.

In August 2022, the government released a consultation paper outlining several potential changes aimed at making the GAAR more robust. It describes alternatives for significant modifications to each of the three requirements, some of which are open for comment while others are not.

Although the consultation paper identifies ways to expand the GAAR, it doesn’t articulate why the government believes the law falls short of meeting its objective of targeting transactions that cause abusive tax avoidance. Rather, it simply proceeds on the basis that changes are necessary to modernize the GAAR.

A number of the suggested revisions could be detrimental to routine tax planning. For example, the government has indicated it may expand the definition of a transaction to include a choice, which could mean taxpayers who don’t make the least tax-effective choice could be considered a participant in an avoidance transaction.

Another suggested change is to have taxpayers (rather than the tax authority) bear the burden of establishing that the disputed transactions are consistent with the policy underlying the relevant statutory scheme. This would put taxpayers in the difficult position of having to demonstrate the underlying policy of the relevant statutory scheme and then positively prove that they didn’t misuse or abuse it.

The government is also contemplating adding an explicit rule that incorporates consideration of economic substance into the GAAR analysis. If such a rule is adopted, it would represent a fundamental shift in Canadian tax policy. A longstanding tenet of Canadian tax law is that tax is levied on the basis of legal and contractual relationships. The consultation paper leaves many questions unanswered about how the government intends to integrate an economic substance analysis into Canadian law without undermining this fundamental principle of the Canadian tax system.

Submissions made in response to the consultation paper have questioned the need for the proposed amendments, given the GAAR’s overwhelming success rate. Furthermore, concurrent changes are being made in Canada to impose mandatory disclosure obligations on taxpayers who undertake tax avoidance transactions or other transactions of interest. New rules also will require the reporting of uncertain tax positions and expand the audit powers of the Canadian tax authority.

As such, it remains questionable whether any benefits gained from amending the GAAR would outweigh the potential negative effects caused by the proposed changes, and whether such an overhaul is even warranted given the increased reporting requirements and expanded administrative powers.

GAAR Decision Forthcoming From Supreme Court

It may be that a decision in Deans Knight will shed further light on the future of the GAAR and spark a more measured dialogue as to the scope of any potential amendments. The case concerns the application of the GAAR to a series of transactions involving the use of tax losses. In general, for Canadian tax purposes, restrictions are placed on the availability and use of losses following an acquisition of control.

The question before the Supreme Court is whether the transactions at issue avoided an acquisition of control in a manner that was abusive. At the Federal Court of Appeal, the Crown persuaded the court to depart from the established legal standard for corporate control (being de jure control), and the court introduced a novel “actual control” standard that it applied in the context of the GAAR.

The Tax Executives Institute and the Canadian Chamber of Commerce intervened with submissions to the Supreme Court regarding the GAAR’s scope and the potential deleterious effects of introducing a new actual control standard. They argued that the GAAR’s proper function is determining whether transactions are abusive based on the legislative scheme set out in the statute; it’s not to rewrite legislative schemes that rely on established legal concepts simply because a taxpayer has undertaken a primarily tax motivated transaction. It was also argued that the approach advocated by the Crown—where the courts interpret and apply generally understood legal concepts differently based on tax motivation—is unworkable because many ordinary commercial transactions are structured to minimize taxes.

Concluding Observations

The Deans Knight ruling will provide further guidance from our highest court on interpreting the GAAR and our established framework. At the same time, it is clear that the government is contemplating fundamental changes to the GAAR itself. Both developments foreshadow potentially significant implications for the tax landscape in Canada.

In its current form, the GAAR has operated effectively in striking a balance between achieving certainty in tax planning and countering tax abuse. Although the government understandably is focused on refining the tools available to combat abusive tax avoidance, the methods for doing so should be more precise to ensure that ordinary commercial transactions aren’t caught in the crosshairs.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Pooja Mihailovich and Joanne Vandale are partners in the Tax Group at Osler, Hoskin & Harcourt LLP. They specialize in tax litigation and dispute resolution.