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. In other words, to order his or her affairs to lower the overall tax burden. This is the essence of tax planning.
This general rule is modified by principles of law, including by the General Anti-Avoidance Rule. The General Anti-Avoidance Rule (“GAAR”) is one that is applied to the whole of the taxing statute, and not to particular actions or parts. Just remember, there are specific anti-avoidance rules that may apply to your particular circumstances. That said, 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. The GARR only works in very narrow circumstances and only when the government can meet the pre-conditions. The pre-conditions 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 payable. The battle between taxpayer and the taxman, 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.