Copyright 2010, Blake, Cassels & Graydon LLP
Originally published in Blakes Bulletin on Tax, June 2010
Both the Canadian federal and Quebec provincial governments have released further material on the new mandatory reporting regimes applicable to certain "aggressive" tax transactions. On May 7, 2010, the federal government released proposals for consultation. Quebec is further along in the process and tabled draft legislation on May 11, 2010. These developments are part of a larger worldwide trend that has seen moves toward increased mandatory tax disclosure in the United Kingdom and, more recently, the United States.
Although there is some similarity, the Canadian and Quebec concepts of aggressive tax planning (ATP) are not identical and the reporting regimes generally have considerable differences. Under both regimes, the mandatory disclosure requirements will only apply if the taxpayer has made certain arrangements with an advisor or promoter (e.g., confidentiality protection, conditional fee arrangements or, in the case of the federal regime, other loss protection arrangements). Under both the federal and Quebec regimes, the mandatory disclosure appears to be targeting marketed tax transactions to allow the federal and Quebec governments to identify these types of transactions quickly. However, the Quebec proposals then go much further by introducing changes to the Quebec general anti-avoidance rule (the Quebec GAAR) which include a "preventive" disclosure regime for transactions that may be subject to the Quebec GAAR. Under these proposals, the reassessment period for applying the Quebec GAAR will be extended for three years if disclosure of the transaction has not been made (either under the mandatory or preventive regime). In addition, where disclosure has not been made and the Quebec GAAR is assessed, the taxpayer will be subject to a 25% penalty. The extended reassessment period and penalty are applicable even where there is no confidentiality or conditional fee arrangement with an advisor or promoter. Therefore, any time the Quebec GAAR may apply to a transaction, Quebec taxpayers will need to consider whether disclosure of the transaction should be made. A detailed discussion of the federal and Quebec regimes follows.
In the federal budget of March 4, 2010, the federal government announced that it would be consulting on an information reporting regime for certain tax avoidance transactions (see our March 2010 Blakes Bulletin on Tax: 2010 Federal Budget). On May 7, 2010, the federal government released more detailed proposals as part of its public consultation process. The proposed federal regime requires reporting of "avoidance transactions" where certain additional conditions are met. In particular, the government has identified three "hallmarks" of what it considers to be ATP. When an avoidance transaction involves any two of these hallmarks, reporting will be required.
For purposes of the disclosure regime, an avoidance transaction is given the same definition as applies for the general anti-avoidance rule in the Income Tax Act (Canada) (the Federal GAAR). Specifically, a transaction is considered to be an avoidance transaction where it results in a tax benefit and cannot reasonably be considered to have been arranged or undertaken primarily for purposes other than to obtain the tax benefit. Although the federal government has stated that disclosure will not be considered an admission by the taxpayer that a particular transaction is an "avoidance transaction" for purposes of applying the Federal GAAR, it will be interesting to see how this applies in practice since a precondition of mandatory disclosure is the existence of such a transaction.
Hallmarks of Aggressive Tax Planning
The first identified hallmark of ATP exists where a promoter or tax advisor is entitled to fees in respect of the transaction that are attributable in any measure to the amount of the tax benefit or are to any extent contingent upon obtaining the benefit, or are arrived at by reference to the number of taxpayers participating in the transaction or receiving advice as to its consequences. The second hallmark, "confidential protection", is met where the promoter or tax advisor in respect of the transaction places any limitation on the taxpayer's ability to disclose the details or structure of the transaction. The third hallmark, "contractual protection", exists where there is any form of insurance (other than professional liability insurance), indemnity or compensation that protects against a failure to obtain the tax benefit, limits the taxpayer's cost in respect of the tax benefit, or is intended to guarantee a return of the cost of property acquired by the taxpayer in the course of the transaction.
Where an avoidance transaction meets at least two of the three hallmarks, the taxpayer is required to report prescribed information to the Canada Revenue Agency in the year the tax benefit arises. The reporting requirement also applies to any person who has entered into such a transaction for the benefit of the taxpayer, as well as any promoter or tax advisor entitled to the types of fees described above. Where multiple parties are required to file an information return respecting the same transaction, disclosure by any one party will satisfy the obligation for all. Failure to disclose a reportable transaction as and when required will result in suspension of the tax benefit until such disclosure is made and until any penalties levied for the nondisclosure are paid. The new regime will apply to transactions entered into after 2010 and those forming part of a series of transactions commencing before 2011 and completed after 2010.
Penalties for Non-Disclosure
The penalty payable by a taxpayer who has not disclosed a reportable transaction is equal to the total of all fees payable to any promoter or tax advisor entitled to fees of the type identified in the hallmark. Any person who entered the transaction for the benefit of the taxpayer is jointly and severally liable with the taxpayer to pay the penalty, and each promoter or tax advisor is jointly and severally liable for the portion of the penalty representing their fee. A "due diligence" defence exists where the person who failed to disclose a reportable transaction has exercised an appropriate degree of care, diligence and skill to prevent such failure.
The draft Quebec legislation is contained in Quebec Bill 96 (the Quebec Bill) and is consequent to several announcements made by the government of Quebec during the last couple of years regarding Quebec's intention to counter ATP. Quebec first issued ATP measures under Information Bulletin 2009-5 on October 15, 2009 (the Quebec Bulletin). The Quebec Bulletin followed through on announcements made in the 2008- 2009 Quebec Budget and, more specifically, the Working Paper on ATP released on January 20, 2009 (see our February 2009 Blakes Bulletin on Tax: Quebec Releases Consultation Paper on "Aggressive Tax Planning").
Below is a brief summary of the draft legislation related to ATP under the Quebec Bill. Subject to certain exceptions noted below, the legislation is generally effective for transactions carried out by a taxpayer (including a partnership) after October 14, 2009 unless the transactions are part of a series of transactions that began before October 15, 2009 and that were completed before January 1, 2010.
Mandatory disclosure obligations will apply to
- transactions that are subject to a confidentiality agreement by the taxpayer towards the taxpayer's advisor where the transaction results directly or indirectly in a benefit for the taxpayer of C$25,000 or more, or has an impact on the taxpayer's income of C$100,000 or more; or
- circumstances where the remuneration
- of the advisor is conditional on the transaction resulting, in whole or in part, on taxpayer obtaining a tax benefit,
- paid to the advisor is refundable to the taxpayer if the tax benefit fails to materialize, or
- is earned by the advisor only after the expiry of the reassessment period applicable to the transaction at issue.
"Advisor" is essentially defined as a person who provides help, assistance or advice regarding the design or implementation of the transaction, or to a person who either commercializes or promotes the transaction.
Prescribed Form and Timing
The mandatory disclosure is to be made by the taxpayer using Form TP-1079.DI, Mandatory or Preventive Disclosure of Tax Planning (Form TP-1079.DI), which is generally required to be filed no later than the deadline for filing the income tax return for that taxation year. A disclosure will be deemed to have been filed on time if filed within 60 days of the date of assent of the Quebec Bill.
Form TP-1079.DI requires a significant level of detail. The identity of the taxpayer, partnership and its members (if applicable), the advisors and promoters, and other parties involved must be disclosed. In addition, detailed information must be provided with respect to the transaction being disclosed including a complete description of the facts relating to the transaction, a statement of the tax consequences resulting from the transaction, the applicable tax provisions and even the applicable line number(s) on the tax return.
If Revenue Quebec does not request additional information in the 120 days following the filing of Form TP-1079.DI under mandatory reporting (or a voluntary preventive reporting as discussed below), then Form TP-1079.DI is considered to be complete and submitted within the required deadline. Revenue Quebec stated at a Canadian Tax Foundation seminar held in Montréal on March 24, 2010 (the Quebec Conference) that a disclosure will be considered not to have been duly made if a request for information remains unanswered during the time specified in the request.
Failure to Comply
Failure to comply with the mandatory disclosure obligation will expose the taxpayer to penalties starting at C$10,000, which will increase by C$1,000 for each day of non-compliance to a maximum of C$100,000. In addition to these penalties, there is an automatic extension of the reassessment period. Where a taxpayer has a mandatory disclosure obligation, the reassessment period commences only on the later of the date of mailing of the Notice of Assessment or the day Form TP-1079.DI is filed with Revenue Quebec.
Where a taxpayer has a mandatory disclosure obligation and fails to submit Form TP1079.DI, the taxpayer may avoid the imposition of penalties by successfully arguing, in accordance with jurisprudence, a due diligence defence. The Quebec Bill does not provide for a statutory due diligence defence. In this connection, Revenue Quebec indicated at the Quebec Conference that it will look to Quebec case law to interpret the notion of a due diligence defence and, absent any meaningful Quebec case law, Revenue Quebec will seek guidance from case law on directors' liability and federal case law on the goods and services tax regime.
Generally speaking, a due diligence defence normally requires either a reasonable error of fact or assurance that all reasonable measures were taken to avoid a penalty such that a reasonable person would have made the same error under the same circumstances. Revenue Quebec stated at the Quebec Conference that an advisor's opinion filed in support of a due diligence defence may be used by Quebec auditors as part of their audit and may actually form the basis of an assessment against the taxpayer.
Revenue Quebec also indicated at the Quebec Conference that a taxpayer who does not make mandatory disclosure within the time limits can avoid the applicable penalties by making a voluntary disclosure in accordance with Revenue Quebec's voluntary disclosure procedure. However, a voluntary disclosure under Revenue Quebec's voluntary disclosure procedure will not, in and of itself, cause the normal reassessment period to start running. Only mandatory disclosure of all the information required by the prescribed form can revoke the suspension of the limitation period. Revenue Quebec will amend Interpretation Bulletin ADM-4/R2, "Voluntary Disclosures," to reflect these changes.
The Quebec Bill also tabled measures that will help the tax authorities to apply the Quebec GAAR. In order to harmonize the Quebec GAAR with that of other provinces, the concept of bona fide purposes used in the definition of "avoidance transaction" under the GAAR provisions pursuant to the Quebec Taxation Act (QTA) will be clarified to exclude (i) the obtaining of a tax benefit, (ii) the reduction, avoidance, or deferral of tax or any other amount payable under a Quebec law other than the QTA, a law of another province, or a federal law, (iii) the increase of a tax refund or other amount under such laws, or (iv) a combination of any of the above purposes.
The clarifications to the concept of bona fide purposes are applicable for the 2009 and subsequent taxation years, as well as for taxation years in respect of which Revenue Quebec can validly re-determine the tax liability of a taxpayer. They are also applicable to taxation years under objection or appeal by a taxpayer as at October 15, 2009 provided the assessment or reassessment under objection or appeal is based on the application of the Quebec GAAR.
Extension of Reassessment Period and Penalties
The Quebec Bill tabled certain measures specific to transactions where the Quebec GAAR is applicable. In order to provide Quebec tax authorities with additional time to scrutinize so-called avoidance transactions, the Quebec Bill introduced rules that extend the normal reassessment period by an additional three years. Transactions where the Quebec GAAR may apply will therefore have a reassessment period that could extend up to six years (or seven years) as opposed to the normal three-year (or four-year) period.
In addition, taxpayers will also be subject to a penalty equal to 25% of the additional tax and any other additional amount payable resulting from the application of the Quebec GAAR to the avoidance transaction.
Moreover, the "promoter" of an avoidance transaction will be subject to a penalty of 12.5% of the amounts that the promoter received in respect of the avoidance transaction. A promoter is essentially defined as a person or partnership who (i) commercializes, promotes or otherwise supports the development and interest of the avoidance transaction, (ii) is compensated for such and (iii) can reasonably be considered to have played a substantial role in the marketing, promotion or encouragement of the avoidance transaction. Revenue Quebec suggested at the Quebec Conference that some repetition and continuity would normally need to be present for a person to be considered a promoter.
Taxpayers can avoid both the extension of the reassessment period and the application of the new penalties if they previously complied with the mandatory disclosure rules (discussed above) or preventive disclosure rules (discussed below). Although the Quebec Bill does not contain a statutory due diligence defence, both the taxpayer and the promoter may avoid the application of penalties if they are able to successfully argue a due diligence defence in accordance with existing jurisprudence.
The preventive disclosure mechanism is effectively a mechanism available to a taxpayer (including a partnership) to avoid both the extension of the reassessment period and the application of penalties in the context of the Quebec GAAR. Unlike the situations targeted by the mandatory disclosure mechanism (the presence of undertakings of confidentiality and conditional remuneration between the taxpayer and the advisor), the preventive disclosure reporting is voluntary and restricted to circumstances involving the application of the Quebec GAAR. Any time the Quebec GAAR may apply to a transaction, Quebec taxpayers will need to consider whether disclosure of the transaction should be made. In considering whether to make this disclosure, Quebec taxpayers will need to consider the possibility that it may become commonplace in the course of federal income tax audits for the Canada Revenue Agency to ask Quebec taxpayers what disclosures have been made for Quebec purposes.
Similar to the mandatory disclosure mechanism, the preventive disclosure mechanism requires the taxpayer (including a partnership) to complete and file the detailed information prescribed by Form TP-1079.DI as discussed above. The filing deadline for a preventive disclosure is also similar to the deadline for mandatory disclosure reporting as discussed above. The Quebec Bill provides that the filing of Form TP-1079.DI under either the mandatory or voluntary preventative disclosure mechanism may not be considered to be an admission with respect to the application of the Quebec GAAR.
Revenue Quebec confirmed at the Quebec Conference that a taxpayer who has not filed a timely preventive disclosure can also make a voluntary disclosure in accordance with Revenue Quebec's voluntary disclosure procedure to avoid Quebec GAAR-related penalties. If a preventive disclosure was not filed by the deadline and the Quebec GAAR applies, the normal reassessment period will still be extended by three years. Revenue Quebec will amend Interpretation Bulletin ADM-4/R2, "Voluntary Disclosures," to reflect this.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.