New reporting requirements for tax avoidance transactions

As promised in the 2010 federal budget, the minister of finance has released details of a proposed new reporting requirement for certain tax-avoidance transactions. Although the proposals are not as far-reaching as recently announced rules in Quebec and the US, they would represent one of the most significant federal legislative tools for tackling tax avoidance since the introduction of the general anti-avoidance rule (GAAR) in 1988.

The detailed proposals suggest broader measures than those outlined in the budget. In particular, not only taxpayers who engage in certain tax avoidance transactions would be subject to the reporting requirements, but also tax advisors and promoters. Further, all parties who fail to disclose as required would be potentially jointly and severally liable for penalties, subject to individual liability caps and a due diligence defence. The purpose of the proposed rules is to assist the Canada Revenue Agency (CRA) in identifying aggressive tax planning in a timely manner so that the application of the GAAR can be considered. However, the proposals state the disclosure of a reportable transaction would not constitute an admission that the GAAR applies to the transaction, or that the transaction is an avoidance transaction. This seems contradictory, since the proposals also maintain that a transaction must be an "avoidance transaction" in the first place in order to be a reportable transaction.

The proposed rules identify reportable transactions by reference to certain "hallmarks" that the government believes reflect circumstances that are common in tax-avoidance transactions. Flow-through shares and tax shelters would be exempt from the new rules, since they already have their own reporting regimes.

The failure to report an avoidance transaction would result in the suspension of the associated tax benefit, although the tax benefit could be reinstated if the taxpayer files with the CRA the information that should have been reported and pays the requisite penalty.

The new regime, if enacted, would apply to transactions entered into after 2010 and to any part of a series of transactions completed after 2010. Interested parties are invited to provide comments on the proposals by 7 July 2010.


Details of the proposals

What kinds of transactions must be reported?

In order to be reportable, a transaction would have to be an "avoidance transaction" as defined for the purposes of the GAAR in subsection 245(3). In general, this is a transaction that results in a tax benefit, either by itself or as part of a series of transactions, unless the transaction may reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain the tax benefit.

An "avoidance transaction" would be reportable if it had at least two of the following three hallmarks:
- The promoter or tax advisor was paid a "contingency fee;"
- The promoter or tax advisor required "confidential protection" with respect to the transaction; and/or
- "Contractual protection" was provided to the taxpayer.

The concept of a contingency fee as described in the proposals is fairly broad. It would include fees payable to a promoter or tax advisor that are to any extent attributable to the amount of the tax benefit from the transaction, contingent upon the realization of a tax benefit from the transaction, or attributable to the number of taxpayers who participate in the transaction or who have been given access to advice from the promoter or advisor regarding the tax consequences of the transaction.

Confidential protection would mean any limitation on disclosure of the details or structure of the transaction that is placed by a promoter or tax advisor on the taxpayer or on a person who entered into the transaction for the benefit of the taxpayer.

Contractual protection would include any form of insurance, indemnity or compensation that protects against a failure of the transaction to result in any portion of the tax benefit being sought (other than a contingency fee described above). It would also extend to amounts paid to reimburse any expenses incurred in respect of a tax benefit arising from a transaction and amounts intended to guarantee a return of the cost of any property acquired by the taxpayer in the course of the transaction.


What information must be provided and when?

An information return with respect to a reportable transaction would have to be filed in prescribed form on or before the taxpayer's filing due date for the taxation year in which the tax benefit "arose."

The proposals do not elaborate on when a tax benefit arises. In many cases, this will be obvious. However, there are circumstances that can be conceived where the timing is not clear. For example, if the proposals were to apply to an avoidance transaction that results in the creation of a tax attribute such as "paid-up capital," does a tax benefit arise on the creation of the tax attribute or on its subsequent use? And what if there are several subsequent uses by the taxpayer, or even several subsequent uses by several taxpayers?

The prescribed information form has not been published, and the proposals do not elaborate on the information that would have to be filed, but presumably it would include a description of the transaction, the quantum of the tax benefit, and possibly the identities of the promoter and the tax advisor.

The CRA has indicated that it will publish guidance concerning how a transaction is to be reported and the information to be reported. It is unclear whether such guidance will be provided before the due date for comments on the proposals.


Who is required to report?

The following persons would be required to report:
- A person who seeks to obtain a tax benefit from a reportable transaction
- A person who enters into a reportable transaction for the benefit of another taxpayer
- Any promoter or tax advisor in respect of the reportable transaction who is entitled to fees as contemplated in the hallmarks

It is not clear what it means to enter into a transaction "for the benefit" of a taxpayer. The proposals cite as an example where a corporation enters into a series of transactions that results in a tax benefit accruing to a current or future shareholder of the corporation. Presumably, this concept will also be clarified when draft legislation is released.

If more than one person would be required to file an information return in respect of a reportable transaction, the filing of a complete disclosure by one of the parties would satisfy the obligation of each party.


What are the consequences of failure to report?

Suspension of the tax benefit

Any tax benefit sought by a taxpayer from a reportable transaction would be suspended until the transaction is reported and the penalty for failure to disclose the transaction was paid.


Penalty for failure to report

In the case of any taxpayer who sought a tax benefit from the reportable transaction, the penalty for failure to disclose would be the total of all fees in respect of the transaction, described in a hallmark, which a promoter or tax advisor is entitled to receive (presumably, mainly from the particular taxpayer).

All other persons who entered into the transaction for the benefit of the taxpayer would be jointly and severally liable with the taxpayer to pay that penalty. Each promoter or tax advisor would also be jointly and severally liable with the taxpayer — and with all the other persons who entered into the transaction for the benefit of the taxpayer — to pay the portion of the penalty that is equal to all the fees that the promoter or tax advisor is entitled to receive and that are included in computing the penalty.


Due diligence

No person would be liable for a penalty for a failure to report if the person has exercised the degree of care, diligence and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances.


Conclusion

The proposed new reporting regime does not go as far as the recently announced US reporting requirements for uncertain tax positions, although the proposals apply to a broader range of taxpayers (e.g., including individuals and partnerships) and there is no de minimis protection similar to that in the US. The requirement that the avoidance transaction bear at least two of the three listed hallmarks would limit the number of reportable transactions.

Nevertheless, the proposed reporting requirement would represent a significant new tool in the CRA's information-gathering arsenal and, if enacted, would likely result in an increase in audit activity. The proposals leave some significant questions unanswered, particularly the specific information that would be required to be disclosed and how solicitor-client privilege would be affected.