Tax Avoidance & Tax Planning- Introduction
The line between effective tax planning and tax avoidance is not always a bright one. In fact, taxpayers may find themselves in the crosshairs of the Canada Revenue Agency (“CRA”) even if they have complied with the letter of the law. Tax avoidance includes transactions where the taxpayer obeys the literal interpretation of tax law but violates the spirit or intent of the Canadian Income Tax Act.
Any income tax planning that is carried out has to take into account that many tax avoidance transactions are caught using specific anti-avoidance rules as set out in the Tax Act. In addition, tax planning can be thwarted by the General Anti-Avoidance Rule that can be used by CRA when there is no specific tax provision that addresses the transaction in question.
The General Anti-Avoidance Rule (“GAAR”)
Subsection 245(2) of the Income Tax Act(“ITA”) sets out GAAR. This rule permits the CRA to impose adverse tax consequences to deny any tax benefits resulting, directly or indirectly, from an avoidance transaction. Furthermore, GAAR also applies to a series of transactions that include the avoidance transaction.
The three key GAAR terms: “tax benefit”, “tax consequences” and “transaction” are defined in subsection 245(1). These definitions are purposely broad and many transactions may be subject to scrutiny under GAAR. As a result, GAAR is a powerful CRA audit tool. As a result the true scope of the general anti-avoidance rule has been clarified by court decisions.
The GAAR Framework: Canada Trustco Mortgage Co. v Canada [2005 SCC 54]
The Supreme Court decision in Canada Trustco Mortgage Co v Canada(“Trustco”) developed a three step test for the application of GAAR.
- Does a tax benefit arise from the transaction or series of transactions (of which the transaction is a part)?
- Is the transaction that gives rise to the tax benefit an avoidance transaction?
- Is the avoidance transaction that gives rise to the tax benefit abusive?
The third step of the test is the most challenging part of the analysis and the Trustco case provides an in-depth exposition of what constitutes “abusive tax avoidance.” The central enquiry when determining abuse (taking a textual, contextual and purposive approach) is whether the transaction frustrates or defeats the object, spirit or purpose of the relevant income tax provisions.
In other words, if a tax benefit received through a transaction or series of transactions is not consistent with the object, spirit or purpose of the act, abusive tax avoidance has occurred.
Burden of Proof: Who is responsible for proving what?
The burden of proof for tax litigation (called the onus) differs from other areas of the law. In the Tax Court of Canada (the “Tax Court”) CRA is entitled to make factual assumptions and a taxpayer’s Canadian tax lawyer is required to refute or present evidence to challenge the CRA’s factual assumptions. With respect to GAAR cases, the taxpayer is required to refute the CRA’s position that 1) a tax benefit arose from the transaction and 2) that the transaction was an avoidance transaction.
This responsibility or onus is reversed for the third step of the test. The CRA must establish that there was abusive tax avoidance. Taxpayers should note that if there is uncertainty around whether abuse occurred, the benefit of the doubt goes to the taxpayer.
Select GAAR Rulings
There are numerous GAAR decisions that have been decided by different levels of court. As examples we have summarized a successful and an unsuccessful GAAR application.
MacKay v. Canada [2008 FCA 105]
A group of respondents acquired a shopping centre. While the series of transactions were made for a bona fide purpose other than to receive a tax benefit, the primary purposes of particular transactions were to transfer an accrued loss of $6M to the purchasers. These transactions were found to violate the spirit and purpose of s. 18(13) and s.96 of the ITA. The purpose of s. 18(13) is to prevent the recognition of a superficial loss by a taxpayer who is in the business of lending money while s.96 lays out the taxation rules that apply to partnerships.
GAAR did not apply:
Evans v. The Queen [2005 TCC 684]
A taxpayer engaged in a sophisticated tax planning strategy to put corporate funds into the taxpayer’s hands while minimizing tax payable. The series of transactions were enacted through multiple corporations and a limited partnership. The plan was meticulously executed and each specific rule of the ITA that was engaged was respected and observed. The same result (corporation funds into a taxpayer’s hands) could have been achieved through the issuance of a dividend, but at a higher tax cost. GAAR was found not to apply for the following reasons:
- None of the transactions defeats or frustrates the purpose of the ITA.
- The transactions did not lack economic substance (they were not shams).
- Treating the transactions as abusive would frustrate Parliament’s intention that “taxpayers take full advantage of the provisions in the ITA that provide tax benefits.”
- It cannot be reasonably concluded that the transactions were carried out in a manner inconsistent with the object, spirit or purpose of the act.
- Nothing was put before the court that persuaded the Judge that there was any abuse of the ITA read as a whole.
Tax Tips for a Taxpayer assessed under GAAR
GAAR is an interesting concept and there is ongoing academic debate on the topic. Taxpayers should note that each GAAR case is fact specific and that outcomes may turn on nuances. Any person assessed under the GAAR provisions of the ITA would benefit from tax legal advice. As mentioned above, many a transaction may fall into the ambit of GAAR. By receiving tax planning advice early in the process, a taxpayer can lower the risk of being assessed or reassessed under these provisions. Taxpayer due diligence before engaging in a tax planning transaction is very important as the CRA may levy gross negligence penalties if the scheme was already found to be subject to GAAR by the Supreme Court of Canada. If you are facing a GAAR assessment, or want to carry out tax planning, contact our expert Canadian tax lawyers today.