New penalty remains as GAAR legislation tabled

The federal government’s latest refinement of its general anti-avoidance rule (GAAR) revamp failed to provide any penalty relief — and actually made the penalty slightly worse.

The final GAAR proposals in Bill C-59, the budget implementation bill that passed first reading in the House of Commons on Nov. 30, contained minor modifications compared with the draft legislation released in August.

“Frankly, I think these changes are a big nothing burger,” said Steve Suarez, a partner with Borden Ladner Gervais LLP in Toronto. He’s more troubled by the Department of Finance’s insistence on proceeding with a new automatic penalty.

Under C-59, the penalty would be calculated as 25% of the additional tax owing by a taxpayer as a result of the GAAR’s application. This is slightly harsher than the calculation in the August proposal since it includes the value of refundable tax credits lost when GAAR was applied. The total amount is then reduced by the value of any “gross negligence” penalty already imposed, to avoid the risk of duplication.

But it’s the lack of discretion regarding the imposition of the penalty that bothers Suarez, since tax officials have no room to distinguish between cases driven by aggressive tax planning and those involving legitimate interpretational uncertainty.

“You could win at the Tax Court and the Federal Court of Appeal, then lose 5-4 at the Supreme Court of Canada and the penalty still applies to you,” Suarez said. “It’s something that fundamentally fails the basic test of fairness.”

The final version of the GAAR legislation also left intact an exception preventing the penalty’s imposition in cases involving transactions that are “identical or almost identical” to those that were the subject of government guidance or court decisions indicating the GAAR would not apply.

In addition, taxpayers will be able to avoid penalties and reassessments related to transactions that are disclosed — whether voluntarily or as required legislatively — under the Canada Revenue Agency’s new mandatory disclosure regime, which took effect in June.

According to Toronto tax lawyer Pooja Mihailovich, a partner with Osler Hoskin & Harcourt LLP, other key consistencies between C-59 and the August draft GAAR proposals include a three-year extension to the statutory limitation period for assessment or reassessment when the rule applies, and the lowering of the threshold for an avoidance transaction from one whose primary purpose is obtaining a tax benefit to a transaction where a tax benefit is “one of the main purposes.”

However, the C-59 version of the rule, which is scheduled to come into force in 2024 once the bill has received royal assent, abandons the draft legislation’s proposal to create a rebuttable presumption of abuse or misuse for transactions that are “significantly lacking in economic substance.”

Instead, the new test says the lack of economic substance will be an “important consideration” that “tends to indicate” that the transaction results in misuse or abuse.

“There are still concerns with how the test will apply in practice,” Mihailovich said, noting that explanatory notes issued alongside C-59 suggest that misuse and abuse will still be considered the “starting point” for analyzing transactions lacking in economic substance.

“It remains to be seen how the proposed economic substance test will interact with the existing misuse and abuse analysis, which is rooted in examining the policy of the relevant provisions as opposed to starting the analysis with a finding that there has been a misuse and abuse,” she added.

Suarez said the courts were already accounting for the economic substance of transactions in GAAR cases: “The changes that are proposed on economic substance don’t seem to really move the needle in terms of what the existing jurisprudence does.”

If C-59 passes as written, Mihailovich said taxpayers and their advisors will need to take a more proactive approach when executing transactions to avoid triggering the economic substance test.

“Diligence undertaken at the planning stage will be of assistance not only in defending against a GAAR assessment but also against any penalty that may be concurrently imposed,” she said.