I. Background

As part of the 2021 Canadian federal budget, the government announced that it would be expanding the existing “mandatory disclosure rules” in the Income Tax Act (Canada) (the ITA) in accordance with the Organisation for Economic Co-operation and Development (OECD)’s Base Erosion Profit Shifting Action 12 Report.  The budget proposals (the Proposals) included:

1. Expanding existing “reportable transactions” rules in section 237.3 of the ITA;
2. Creating a new category of “notifiable transactions”;
3. Requiring “certain corporations” to report “uncertain tax treatments”;
4. Extending the normal reassessment period where there is non-compliance with reporting rules; and
5. Expanding penalties for non-compliance with reporting rules.

On February 4, 2022, the Department of Finance released draft legislation (Draft Legislation) to give effect to the Proposals. The Department of Finance indicated that the Draft Legislation is being circulated for consultation and is inviting comments by April 5, 2022. However, it is intended that the Draft Legislation, once passed into law, will be retroactive to taxation years and transactions occurring in taxation years, that begin after 2021.

In addition, the Minister of National Revenue (Minister”) with the concurrence of the Minister of Finance designated six types of transactions or arrangements that will constitute “notifiable transactions”.  While the notifiable transactions will be discussed below, it is noteworthy that the first designated transaction involves arrangements that intentionally cause a private Canadian resident corporation to not qualify as a “Canadian-controlled private corporation” (CCPC). These arrangements have become quite commonplace over the past few years as a means of avoiding refundable taxes on investment income that would otherwise apply to a CCPC. The fact that a transaction or arrangement is subject to mandatory disclosure does not necessarily mean that it is prohibited under the ITA. However, the requirement to report the details of the transaction or arrangement to the Canada Revenue Agency (CRA) certainly increases the likelihood of audit and possible reassessment under other provisions of the ITA such as the general anti-avoidance rule (GAAR).

II. Reportable transactions

Canada’s existing mandatory disclosure rules in respect of reportable transactions require the transaction to be an “avoidance transaction” within the meaning of the GAAR in subsection 245(2) of the ITA, and to havetwo of three “generic hallmarks” – (i) a contingent fee arrangement for a promoter or tax advisor; (ii) confidential protection for a promoter or tax advisor and (iii) contractual protection for a taxpayer.

Under the Draft Legislation, only one of the above hallmarks is required for a transaction to be reportable, provided that it can be reasonably concluded that one of the main purposes of entering into the transaction is to obtain a tax benefit (a lower threshold than the existing “primary purpose” test required for an avoidance transaction under the GAAR).

A taxpayer who enters into a reportable transaction (or another person who enters into the transaction for the benefit of the taxpayer) and a promoter or advisor (except to the extent solicitor-client privilege applies), are required under the Draft Legislation to report the transaction to the CRA within 45 days of the earlier of:

1. The date the taxpayer (or the person who entered into the transaction for the benefit of the taxpayer) became contractually obligated to enter into the transaction; and
2. The date the taxpayer (or the person who entered into the transaction for the benefit of the taxpayer) actually enters into the transaction.

Further, it will no longer be acceptable for a person to report a reportable transaction to the CRA on behalf of themselves and all other persons required to report that same transaction under the relevant provisions of the ITA. For reportable transactions entered into after 2021, each involved or affected person will be required to file the required information return for the particular reportable transaction.

III. Notifiable transactions

Notifiable transactions is a new category of transactions introduced by the Proposals that include transactions that the CRA has found to be abusive and transactions identified by the CRA to be “transactions of interest”. The concept is similar to “listed transactions” under US tax rules.

A notifiable transaction is defined in the Draft Legislation to mean a transaction that is the same as, or substantially similar to, a series of transactions that has been designated by the Minister (with the concurrence of the Minister of Finance). Concurrent with the release of the Draft Legislation, the Minister designated six different series of transactions as notifiable transactions. These transactions are discussed below.

A taxpayer who enters into a notifiable transaction (or another person who enters into the transaction for the benefit of the taxpayer) and a promoter or advisor (except to the extent solicitor-client privilege applies), would be required under the Draft Legislation to report the transaction to the CRA within 45 days of the earlier of:

1. The date the taxpayer (or the person who entered into the transaction for the benefit of the taxpayer) became contractually obligated to enter into the transaction; and
2. The date the taxpayer (or the person who entered into the transaction for the benefit of the taxpayer) actually enters into the transaction.

Every information return required to be filed in respect of a notifiable transaction must: 

1. Describe the expected tax treatment and all potential benefits to result from the transaction;
2. Describe any contractual protection with respect to the transaction;
3. Describe any contingent fees with respect to the transaction;
4. Identify and describe the transaction in sufficient detail for the Minister to be able to understand the tax structure of the transaction;
5. Identify the provisions relied upon for the expected tax treatment;
6. Identify every person required under subsection 237.4(4) of the ITA to file an information return in respect of the transaction; and
7. Provide such other information as is required by the information return.

As with reportable transactions, the taxpayer for whom the tax benefit results from the notifiable transaction, the person, if applicable, who entered into the notifiable transaction on behalf of the taxpayer, every adviser or promotor in respect of the notifiable transaction and every person who does not deal at arm’s length with the advisor or promotor in respect of the notifiable transaction and who receives or may receive a fee in respect of the notifiable transaction, is required to file this information return. In other words, a single information return may not be filed on behalf of all affected or involved persons.

Notifiable Transactions Designated by the Minister of National Revenue

The six types of transactions designated by the Minister deal with the following matters:

1. Manipulating CCPC status;
2. Straddle creation transactions using a partnership;
3. Avoiding the 21-year deemed disposition rule for trusts;
4. Manipulation of bankrupt status to reduce debt forgiveness;
5. Avoidance of acquisition of control of a corporation in certain circumstances; and
6. Back-to-back lending to avoid either thin capitalization rules or non-resident withholding tax.

1. Manipulating CCPC Status

There are three designated transactions that the Minister highlighted with respect to this type of planning:

1. Avoiding “Canadian corporation” status by continuing a CCPC under the laws of a foreign jurisdiction;
2. Avoiding “Canadian-controlled” status by issuing a majority of special, voting shares (a.k.a. “skinny” voting shares) to a non-resident person or public corporation; and
3. Avoiding “Canadian-controlled” status by issuing an option to a non-resident person or public company for the acquisition of a majority of the voting shares of a corporation.

2. Straddle losses involving a partnership

Straddle transactions involving partnerships have been used as a mechanism to create tax losses. For example, a partnership enters into a straddle agreement and closes out the gain leg first and allocates the gain to the initial partner. The partnership interest is then acquired by a new person following which the loss leg is closed out and allocated to the new partner. These types of transactions have been designated by the Minister as notifiable transactions.

3. Avoiding the 21-year deemed disposition rule

The Minister identified three designated transactions with respect to avoidance or deferral of the 21-year deemed realization rule or the avoidance of the rules in subsections 107(5) and (2.1) of the ITA:

1. The indirect transfer of trust property to another trust by transferring the property to a holding company owned by the recipient trust on a tax-deferred basis prior to its 21-year anniversary.
2. The indirect transfer of trust property to a non-resident by transferring the property to a holding company owned by one or more non-resident beneficiaries of the trust on a tax-deferred basis prior to its 21-year anniversary.
3. The transfer of trust value using a deemed dividend resulting from the redemption shares in the capital of an operating company held by a trust that is designated by that trust to be received by a holding company owned by the recipient trust.

4. Manipulation of bankrupt status

The Minister has designated transactions whereby bankruptcy status is temporarily obtained in order to avoid the tax consequences of debt forgiveness. The series contemplates a person or partnership being assigned into bankruptcy following which a commercial debt is settled. At any point in time after the debt is settled, the person or partnership files a proposal to annul the bankruptcy.

5. Avoiding deemed acquisition of control

The Minister designated certain transactions that avoid the tax attribute trading restrictions in section 256.1 of the ITA by relying on one of the purpose tests in that section to conclude that the restrictions do not apply to the particular transactions or events.  

6. Back-to-back arrangements

The Minister designated transactions aimed at taxpayers who attempt to circumvent the thin capitalization rules or the application of non-resident withholding tax under Part XIII of the ITA through the use of back-to-back lending arrangements involving intermediaries. While there are currently back-to-back loan rules in the ITA, the burden is on the CRA to identify the transactions. By designating these arrangements as notifiable, audit and potential reassessment becomes more likely.

IV. Reportable uncertain tax treatment

Under the Draft Legislation, an uncertain tax treatment is a tax position taken in a corporation’s income tax filings for which uncertainty as to the correctness of the position is noted in the relevant corporation’s financial statements for the year. The Draft Legislation would require a “reporting corporation” to file an information return in respect of a reportable uncertain tax treatment at the same time its income tax return is due.

A “reporting corporation” for a taxation year is a corporation that:

1. Has audited financial statements for the taxation year prepared in accordance with IFRS or other country-specific GAAP relevant for corporations that are listed on a stock exchange outside of Canada;
2. The carrying value of the corporation’s assets is greater than or equal to $50 million at the end of the year; and
3. The corporation is required to file a Canadian return of income for the taxation year.

The Department of Finance did not issue draft regulations along with the Draft Legislation which would provide specific details on the information to be provided in the information return. However, the backgrounder issued by the Department of Finance indicated that it was expected that the following information would be included in the prescribed information with respect to each reportable uncertain tax treatment:

1. The taxation year to which the reportable uncertain tax treatment relates;
2. A description of the relevant facts;
3. With respect to the transaction to which the reportable uncertain tax treatment relates, a description of:
1. The provisions relied upon for determining the tax payable, refund of tax or other amount under the ITA;
2. The differences between such tax payable, refund of tax or other amount, determined in accordance with relevant financial statements and tax treatment of the corporation; and
3. Whether those differences represent a permanent or temporary difference, involve a determination of the value of any property and involve a computation of basis; and
4. Such other information required by the Minister of National Revenue.

V. Reassessment period

Under the Draft Legislation, the normal reassessment period would not commence in respect of a transaction that requires mandatory disclosure reporting until the taxpayer has complied with the reporting requirement. Therefore, a reassessment will not become statute-barred unless the taxpayer complies with the mandatory disclosure reporting rules.

VI. Penalties

The Draft Legislation provides details on the penalties that can be applied in the event of non-compliance with the mandatory disclosure rules. However, the penalties will not apply to transactions that are entered into before the Draft Legislation receives Royal Assent.

Taxpayer - Reportable or Notifiable

With respect to a person who enters into (or benefits from) a reportable or notifiable transaction, the Draft Legislation includes a penalty of CA$500 per week for failure to report the transaction, up to greater of CA$25,000 and 25% of the tax benefit (or CA$2,000 per week, up to the greater of CA$100,000 and 25% of the tax benefit for corporations with CA$50 million or more in assets).

Promoter - Reportable or Notifiable

With respect to an advisors or promoter of reportable or notifiable transactions, the Draft Legislation includes a penalty equal to the total of (i) 100% of fees charged; (ii) CA$10,000 and (iii) CA$1,000 a day while failure continues up to a maximum of CA$100,000.

Corporation - Uncertain Tax Treatment

With respect to a corporation subject to the requirement to report uncertain tax treatments, the Draft Legislation includes a penalty of CA$2,000 per week, up to CA$100,000 for each position.