As part of the 2021 federal budget, the government proposed expanding the existing“ reportable transactions” rules in section 237.3 of Canada’s Income Tax Act (the “ITA”),introducing a new category of “notifiable transactions”, extending the normal reassessment period, and expanding and increasing penalties for non-compliance with reporting rules, among other proposals (collectively, the “Mandatory Disclosure Proposals”).
The application date of the new rules will be the beginning of 2023.
Proposed Changes to Reportable Transaction Obligations
The existing reportable transaction rules apply when the transaction constitutes an avoidance transaction and two of the three following hallmarks are present, which in general terms are:
• a promoter or advisor is entitled to receive contingent fees on the transaction;
• a promoter or advisor obtains confidential protection with respect to the transaction; and
• the taxpayer or certain other persons (including a promotor or advisor) receives contractual protection if the transaction does not achieve the intended tax benefit.
Under the Mandatory Disclosure Proposals and Amended Proposals, a transaction would be reportable if it can reasonably be concluded that one of the main purposes of entering into the transaction is to obtain a tax benefit (a lower threshold than the current “avoidance transaction” requirement) and only one generic hallmark must be present.
New Notifiable Transaction Obligations
The Mandatory Disclosure Proposals introduce reporting for transactions that the Canada Revenue Agency (“CRA”) has found to be abusive, and transactions identified as transactions of interest (i.e., potentially abusive in CRA’s view). A notifiable transaction is defined as a transaction that is the same or substantially similar to a transaction designated by the Minister of Finance (the “Minister”) The Minister has initially designated six types of transactions, which in general terms are:
• manipulating Canadian-controlled private corporation status to avoid anti-deferral rules that apply to investment income;
• creating loss straddle transactions using a partnership;
• avoiding the 21-year deemed disposition of trust property;
• manipulating bankruptcy status to reduce a forgiven amount relating to a commercial obligation;
• relying on certain purpose tests to avoid a deemed acquisition of control; and
• using back-to-back arrangements to circumvent the thin capitalization rules and Part XIII withholding tax.
The Amended Proposals left these rules largely the same but provide that the reporting obligations shall generally not apply to banks, insurance companies and credit unions who do not know that the transaction is a notifiable transaction.
Reporting Obligations and Returns
The Mandatory Disclosure Proposals and Amended Proposals require each taxpayer entering into a notifiable or a reporting transaction or any other person who enters into such a transaction for the benefit of the taxpayer to fulfil certain reporting obligations.
For notifiable transactions, these reporting obligations also apply to all advisors or promoters in respect of the transaction. For reportable transactions, these reporting obligations apply to all advisors or promoters who receive a contingent fee based on tax benefits obtained under the transaction or the number of taxpayers who participate in the transaction, or an advisor or promoter who receives a fee in connection with contractual protection provided in the transaction. However, under the Amended Proposals for both notifiable and reportable transactions, persons who only provide clerical or secretarial services with respect to the planning will not have a reporting obligation.
Under one’s notifiable and reportable transactions obligations, reporting consists of filing an information return setting out detailed information about the expected tax benefits, ITA provisions relied on, and other information including who else may be required to notify CRA under these rules.
Taxpayers, advisors, and promoters who have an obligation to file an information return, must do so within 45 days from the earlier of the date the taxpayer becomes contractually obligated to enter into the transaction or the day the taxpayer enters into the transaction. An exception will apply for reporting information subject to solicitor-client privilege.
The Mandatory Disclosure Proposals contain significant penalties for taxpayers, advisors, and promoters who fail to report or file. For advisors and promoters the penalties are up to the fees charged for the matter plus $110,000.
In addition, the normal reassessment period will not commence until the reporting obligations in respect of a transaction are met. Therefore, if any reporting obligations in respect of a transaction are not met, then the normal reassessment period could be extended indefinitely.
Impact on Tax and Non-tax Advisors
The Mandatory Disclosure Proposals contain lower reporting and filing thresholds than the existing rules, and therefore will oblige advisors to report in instances where aggressive tax planning is not intended and may even apply to routine transactions. While the Amended Proposals attempt to clarify some aspects of the original proposals, the results are mixed. Tax advisors must be aware of the Mandatory Disclosure Proposals and Amended Proposals and review their transactions to ensure their own reporting obligations are met, but also to ensure that all the relevant parties have fulfilled their reporting obligations as well.
Certain non-tax advisors may be required to report or disclose even where their work is not directly tied to providing a tax benefit but is connected to a notifiable transaction or a reportable transaction. These advisors may find it difficult to determine their reporting obligations without knowledge of other transactions involved and/or assistance from tax advisors. Aside from exposure to penalties, non-reporting could substantially prejudice their clients’ interests by delaying the start of limitation periods on tax return assessments. At the same time, unnecessary reporting by advisors may also expose their clients to additional scrutiny by the CRA.
• Proposals are too broad – could capture transactions or series of transactions that would not be considered aggressive tax planning
• Rules are unclear – what constitutes a reportable or notifiable transaction.
• May capture transactions undertaken for bonafide commercial purposes
As of the date of this newsletter, the legislation has not received Royal Assent; however we can be assured there will be significant additional compliance in connection with future income tax planning.