Proposed amendments to mandatory disclosure rules

Background

On February 4, 2022 the Department of Finance ("Finance") announced revisions to the mandatory disclosure rules (the "February Amendments") in section 237.3 of the Income Tax Act (the "Tax Act"). These rules require taxpayers to self-report transactions which involve aggressive tax planning.

The February Amendments were a response to the Canada Revenue Agency's (CRA) finding that the existing mandatory disclosure rules in section 237.3 were "not robust enough to address concerns about aggressive tax planning." The February Amendments were drafted with retroactive effect to transactions entered into after 2021 and proposed to significantly broaden the scope of the rules such that routine commercial transactions with an incidental tax benefit could be caught by the new rules.

After consultation with stakeholders and practitioners, Finance revised the February Amendments and released new draft legislation on August 9, 2022 (the "August Amendments"), which delayed effect of the amendments to transactions entered into after 2022. 

The February and August Amendments also introduced new concepts such as "notifiable transactions" in proposed section 237.4 of the Tax Act, and a requirement for certain corporations to report "uncertain tax treatment" in proposed section 237.5 of the Tax Act. These regimes will also apply to transactions entered into after 2022.

The old rules

Under the current mandatory disclosure rules in the Tax Act, taxpayers must report transactions that are "avoidance transactions" that also contain two of three generic hallmarks. These transactions are defined as "reportable transactions" under the Tax Act. Taxpayers are not often required to self-report under these rules because most commercial transactions do not meet the two of three hallmarks test.

An "avoidance transaction" in this context currently has the same meaning as it does for the general anti-avoidance rule (the "GAAR"), which is a transaction, or part of a series of transactions, that results directly or indirectly in a tax benefit, but does not include transactions that are undertaken primarily for bona fide purposes other than to obtain a tax benefit.

A tax benefit is defined in the Tax Act as a reduction, avoidance, or deferral of tax or other amount payable to the CRA. A tax benefit also includes an increase in a refund under the Tax Act.

The three generic hallmarks of reportable transactions are:

1. the fees of a promotor or tax advisor are contingent on the outcome of the transaction or proportionate to the tax benefit; the promotor or tax advisor obtains confidential protection with respect
2. to the details or structure of the transaction;[1] and
3. the taxpayer obtains contractual protection against the tax outcome of the transaction.

A taxpayer who receives, or would receive if not for the GAAR, a tax benefit from a reportable transaction must report the transaction in the prescribed form to the CRA on or before June 30th of the calendar year following the year in which the transaction was entered into. In addition, advisors or promoters who are entitled to fees that are proportionate to the tax benefit or who have contractual protections may also need to report the transaction.

Penalties for late filing or failing to file are tied to the advisor's or promotor's fees or to the contractual protections available to the taxpayer, depending on the situation.

August Amendments to reportable transactions

The August Amendments, if enacted, will apply to transactions entered into after 2022. This should come as relief to taxpayers and practitioners who expressed concern when the February Amendments were announced with retroactive effect back to January 1, 2022. The August Amendments propose to implement the following key changes.

Refining the definition of "avoidance transaction"

An "avoidance transaction" will include any transaction or series of transaction where one of its main purposes can reasonably be considered as obtaining a tax benefit. This is a departure from the existing definition, as transactions that are undertaken primarily for bona fide purposes other than to obtain a tax benefit will no longer be excluded. This change will result in a lower threshold for finding an avoidance transaction under the reportable transaction rules than currently exists and may lead to disputes with the CRA or litigation at the Tax Court regarding the meaning of "one of the main purposes".

New definition: tax treatment

The August Amendments will define "tax treatment" as a treatment in respect of a transaction or series of transactions that a person uses or plans to use in a return of income or information return. It is important to note that the definition "includes the taxpayer's decision not to include a particular amount in a return of income or information return." The new definition of a tax treatment is relevant in determining whether there is an obligation to report a "reportable transaction". Specifically, if a transaction is a "reportable transaction", and the "tax treatment" results in a tax benefit, there is an obligation to report.

Reportable transactions and the generic hallmarks

The August Amendments will modify the definition of a reportable transaction in a few notable ways:

• Most importantly, reportable transactions will require only one, instead of two, hallmarks.
• The confidential protection hallmark must relate to the "tax treatment", as defined above, of the avoidance transaction.
• The contractual protection hallmark will exclude insurance or an indemnity that is standard commercial practice for parties dealing at arm's length, provided that it does not protect against a specific tax treatment in respect of the avoidance transaction.

Changes to the reporting requirements

Under the August Amendments, every taxpayer who receives a tax benefit or who expects a tax benefit based on their tax treatment of a reportable transaction has an obligation to report.

The timing of reporting obligations has also changed. An information return in the prescribed form must be filed on or before the 45th day after the earliest of:

(i) the day the taxpayer becomes contractually obligated to enter into the reportable transaction; and

(ii) the day on which the person enters into the reportable transaction.

This rule change for timing also applies to tax advisors and promoters that are required to report.

Penalties

Penalties for a taxpayer filing an information return late will be proportionate to the amount of tax benefit they receive, subject to a maximum of $25,000 or 25% of the amount of the tax benefit, whichever is higher.

If the taxpayer is a corporation with a carrying value of assets greater than or equal to $50 million for the last taxation year, the penalty is subject to a maximum amount of $100,000 or 25% of the amount of the tax benefit, whichever is higher.

Penalties for tax advisors or promoters that are required to file will be tied to their fees. The penalty will consist of (i) the amount of fees the advisor or promoter charged for the transaction; (ii) $10,000; and (iii) $1,000 multiplied by the number of days the reporting is late. The amount determined under (iii) is subject to a maximum of $100,000.

The tax benefit may also be denied for a failure to report the transaction.

Notifiable transactions

A new category of mandatory disclosure rules has been proposed for "notifiable transactions" under new section 237.4 of the Tax Act. A notifiable transaction includes a transaction or transaction in a series of transactions that is the same or substantially similar to those designated as notifiable transactions by the Minister of National Revenue and the Minister of Finance.

The rules surrounding notifiable transactions have not changed between the February and August Amendments.

Taxpayers receiving a tax benefit, or who expect to receive a tax benefit, from a notifiable transaction and their advisors must report the transaction in the prescribed form to the CRA. The deadline to self-report is 45 days after the earlier of:

(i) the day the taxpayer becomes contractually obligated to enter into the reportable transaction; and

(ii) the day on which the person enters into the reportable transaction.

The same requirements for filing an information return for a reportable transaction apply to reporting notifiable transactions. The information disclosed would include the expected tax treatment, a description of the structure of the transaction, contractual protections, contingent fees, and a list of all people required to file an information return.

Sample notifiable transactions

The Department of Finance has released six sample notifiable transactions.

1. Manipulating CCPC status to avoid anti-deferral rules applicable to investment income
2. Straddle loss creation transactions using a partnership
3. Avoidance of deemed disposal of trust property
4. Manipulation of bankrupt status to reduce a forgiven amount in respect of a commercial obligation
5. Reliance on purpose tests in section 256.1 to avoid a deemed acquisition of control
6. Back-to-back arrangements

Penalties

Penalties for a failure to disclose a notifiable transaction follow the same rules as reportable transactions.

Reportable uncertain tax treatments

New mandatory reporting requirements are proposed in new section 237.5 of the Tax Act for when there is uncertainty over whether a tax treatment is in accordance with tax law.

A corporation must report to the CRA when the following conditions are met.

• The corporation is required to file a Canadian tax return;
• The corporation has at least $50 million in assets at the end of the financial year;
• The corporation, or a consolidated group of which the corporation is a member, has audited financial statements prepared in accordance with the IFRS or another county's generally accepted accounting principles for domestic public companies; and
• There is uncertainty in respect of the corporation's Canadian income tax reflected in the audited financial statements. This uncertainty is triggered when the tax attributes used in the financial statements (e.g. taxable profit, tax loss, tax bases, unused tax losses, unused tax credits, or tax rates) are not considered consistent with the tax treatment to the CRA.

Disclosure requires a description of the relevant facts, the expected tax treatment, the quantum of the taxes at issue, and whether the uncertainty is temporary or permanent. The report would be required at the same time a corporation's Canadian income tax return is due.

Penalties

Failure by a corporation to report uncertain tax treatments will result in a $2,000 penalty each week the failure continues, subject to a maximum of $100,000 for each particular uncertain tax treatment.

Concluding thoughts

The scope of the proposed amendments to the mandatory disclosure rules is much broader than the existing rules, potentially applying to many commercial transactions where a tax benefit was incidental to its main purpose. This is compounded by substantial penalties for a failure to comply with the reporting obligations and deadlines. Taxpayers should speak with their advisors to determine if these proposed amendments will apply to them.

If you require assistance, please feel free to reach out to the authors or any of our BD&P tax lawyers.

[1] "confidential protection" is defined in s. 237.3(1) as anything that prohibits the disclosure to any person or to the Minister of the details or structure of the transaction or series under which a tax benefit results, or would result but for section 245, but does not include the disclaiming or restricting of an advisor's liability if it does not prohibit disclosure of the details or structure of the transaction or series.