Canada’s General Anti-Avoidance Rule
The general rule in Canadian taxation is that a taxpayer is free to arrange his or her affairs in a way that minimized the total taxes he or she is liable to pay. This is the essence of tax planning – minimizing a taxpayer’s overall tax burden. However, this general rule is modified by a few principles of law, including that the transactions cannot be a sham, they cannot be incomplete, and that they must follow the letter of the law. The general rule is also modified in the Income Tax Act itself through the use of both specific anti-avoidance rules that apply to particular circumstances, and the General Anti-Avoidance Rule (“GAAR”) that applied to the whole of the taxing statute. The GAAR is the focus of this article.
The GAAR is a provision of last resort that allows the Canada Revenue Agency (“CRA”) to modify the tax consequences of otherwise valid and enforceable tax planning, but only in very narrow circumstances and where the government can meet the pre-conditions. The preconditions can be summarized as a series of questions that have to be answered in the affirmative before the GAAR can apply. They are:
- Was there a tax benefit to the taxpayer as a result of the event or transaction?
- Was the event or transaction that gave rise to this tax benefit an “avoidance transaction”?
- Was the “avoidance transaction” giving rise to the tax benefit a misuse or abuse of the object, spirit, or purpose a particular provision or the whole statute?
In most cases the first question is easily answered “Yes”, as the CRA would not be pursuing a taxpayer unless they imagine a different way of structuring the transaction or events that would give rise to more tax being due. The battle in most cases is over questions 2 and 3.
The details of whether a transaction is an “avoidance transaction” or whether or not the transaction is a misuse or abuse of the object, spirit, or purpose of the tax law is difficult to answer in most cases and well beyond the scope of this article. However, as a general rule, if the transactions or series of transactions were entered into primarily for a valid business reason and not a tax reason, the transaction will not be an “avoidance transaction”. Similarly, where the outcome is exactly what the law intended or matches the policy that was promoted or intended to be promoted by the law, then it is not going to be an abuse or misuse of the object, spirit, or purpose of the tax law. Other than these two clear cut cases, there is a great deal of grey area that taxpayers and the CRA can and do fight over.
Where the CRA meets its burden, they can modify the tax outcomes to ones that would have existed had the avoidance transactions not taken place. This can result in significant tax, interest, and possibly penalties being assessed against the taxpayer.