The March 28, 2023 Federal Budget proposed numerous measures previously discussed in our Firm commentary, prepared on Budget night. This article expands on our initial analysis of the proposed amendments to the GAAR.

Table of contents

  1. Introduction
  2. Preamble
  3. Avoidance transaction
  4. Economic substance
  5. Penalty
  6. Reassessment period
  7. Timing for coming into force
  8. Concluding thoughts

    9.  

    Taxpayers are free to arrange their affairs to reduce their tax liability, obviously: it would be absurd if the government deemed every taxpayer's financial position as final at some point, like stopping the music in a game of fiscal musical chairs. The UK Royal Commission on the Taxation of Profits and Income said it best in 1954: "There is no reason to assume that the situation of any one taxpayer at that moment is the fairest possible as between himself and others differently situated [and] it seems wrong to propound any principle that would have the effect of fixing each taxpayer in his situation, without allowing him any chance of so altering his arrangement as to reduce his liability …" That said, tax plagnning subsists within a web of charging and relieving provisions, judicial anti-avoidance doctrines, and specific anti-avoidance rules (SAARs) that foreclose certain strategies. However, SAARs do not completely delineate the boundaries of legitimate planning and abusive avoidance.

    A seminal 1988 paper credited to David Dodge (then Senior Assistant Deputy Minister of Finance) stated the case for a general anti-avoidance rule (GAAR): "… the main limits of the "specific rules" approach … are the practical impossibility of foreseeing every avoidance scheme, the fact that every new rule opens new loopholes, the inequity of adopting rules that may catch transactions that were not intended to be covered, the fact that specific rules outline particular schemes and may therefore help to develop other avoidance strategies and, finally, added complexity. Proposed section 245 is precisely intended to minimize the need to respond repeatedly to abusive strategies by enacting specific legislation every time a purely tax-motivated scheme is marketed."[1]

    Since the [2] Numerous GAAR cases wind their way through the Tax Court of Canada and the Federal Court of Appeal annually. Recently, the Supreme Court of Canada gave judgment in its sixth GAAR appeal, in Deans Knight Income Corp. v. Canada.[3] Five of those six Supreme Court cases involved domestic strategies and the Crown won in four of them – a good track record.

    Despite the Crown's regular and successful use of the [4] The drivers seem to be political, rather than good tax policy.

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    Preamble

    According to the federal Interpretation Act,[5] "[t]he preamble of an enactment shall be read as a part of the enactment intended to assist in explaining its purport and object."[6] Like most things in life and law, a preamble's weight depends on the circumstances and preambles can be important to purposive interpretation. This view assumes that judges need assistance or encouragement to undertake purposive analysis. Budget 2023 stated that the preamble would be added "in order to help address interpretive issues and ensure that the GAAR applies as intended." Given the reasons of a majority of the Supreme Court in Deans Knight, one might reasonably conclude that the courts do not need a Parliamentary reminder.

    The proposed preamble states at paragraph (a) that the [7] Further, and as we noted in our Budget commentary, there is a gap: between abusive tax planning and "tax benefits contemplated by the relevant provisions" exists planning that was neither contemplated nor abusive.

    Paragraph (b) states that the Alta Energy[8] dissent at paragraph 121 (relying on the majority reasons in Lipson[9]) is a distinction that is obvious, but does not affect the actual "certainty, predictability and fairness" principle. At its highest and best, the question of who is entitled to fairness has an easy answer: everyone. But fairness to everyone is not justiciable – at least not in tax, and no GAAR cases have ever (or will ever) be determined based on a standalone fairness argument. The fairness concept in tax disputes is intimately linked to certainty and predictability and, respectfully, the proposed amendment has to be for public consumption rather than for the edification of the courts.

    Finally, paragraph (c) asserts that the Lehigh Cement[10] that the Crown cannot discharge its burden to establish misuse/abuse just by asserting that a transaction was unforeseen or exploited an unnoticed legislative gap. That said, comments at paragraph 45 of Deans Knight intimate that while abusive tax avoidance may involve unforeseen tax plans, the GAAR is not limited to that, as it is designed to support the integrity of the tax system by addressing strategies that frustrate the object, spirit and purpose of the relevant provisions.

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    Avoidance transaction

    The definition of avoidance transaction is proposed to be amended to lower the threshold from a primary purpose test to a "one of the main purposes" test. While the bar would be lower, it would not be entirely non-existent – if tax saving was incidental or "simply a consideration"[11] then a transaction may not be an avoidance transaction. That said, a critic may wonder whether the amendment is necessary.

    One of the few or only cases in which the Crown would have benefited from a lower threshold was Spruce Credit,[12] in which no avoidance transaction was found, although the trial judge concluded that the tax benefit may arguably have resulted from a misuse or abuse of the relevant provisions. Changing the law significantly to address a single, unique case may be criticized as excessive. Nonetheless, it could have been worse – there are lower bars (one of the purposes, for example).

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    Economic substance

    Before critiquing the proposed amendments that would include an economic substance analysis under the [13]

    Second, the [14] although it has been argued that the GAAR did not reverse Stubart per se.[15] That said, the GAAR's avoidance transaction criterion (a transaction must have been "undertaken or arranged primarily for bona fide purposes other than to obtain the tax benefit") is the broader manifestation of the business purpose test abolished by Stubart. Establishing a statutory transactional purpose test was said to be an appropriate means to interpret the law in accordance with Parliamentary intent, because "most provisions are intended to apply to real economic transactions as opposed to transactions carried out solely for the purpose of obtaining an unintended tax benefit."[16]

    Third, the Explanatory Notes to the 1988 legislation that included the GAAR stated that the GAAR:

    “Recognizes that the provisions of the Act are intended to apply to transactions with real economic substance, not to transactions intended to exploit, misuse or frustrate the Act to avoid tax. It also recognizes, however, that a number of provisions of the Act either contemplate or encourage transactions that may seem to be primarily tax-motivated. … It is not intended that section 245 will apply to deny the tax benefits that result from these transactions as long as they are carried out within the object and spirit of the provisions of the Act read as a whole.”

    There is a lot to unpack in the above statement. With respect to “transactions with real economic substance”, the argument is that tax law does not subsist in a vacuum but rather sits astride private relationships governed by “general law”, so the ITA’s provisions speak to transactions entered into for a “real purpose”.[17] Flowing from that conclusion is the idea that transactions that are solely engineered to achieve a tax benefit do not accord with the ITA unless they fall within limited circumstances contemplated or expressly encouraged by the ITA. Once again, a criticism is that there is more to tax planning than a relatively crude distinction between transactions with “real economic substance” and abuse. Not every strategy need be blessed by the ITA to withstand a GAAR challenge.[18] Further, Sasseville’s 1988 paper went back to Stubart and the Supreme Court’s adoption of Drieger’s modern rule to confirm that the misuse or abuse analysis in s. 245(4) is an express recognition of that interpretive rule: the GAAR is not meant to apply to transactions, even if tax-driven, if they are do not violate the object and spirit of the ITA.

    A way to harmonize the commentary from Finance and senior officials may simply be that the GAAR, as originally conceptualized, contemplated "real economic substance" at the avoidance transaction stage as part of reinstituting the business purpose test (writ more broadly as non-tax purpose), while the misuse/abuse stage was meant to be an interpretative rule devoted to determining the object and spirit of the relevant provisions, at which stage economic substance is not integral. If correct, this conclusion challenges the addition of "economic substance" to the misuse/abuse analysis as set out in the proposed amendments.

    Finally, the courts have considered economic substance in a Canada Trustco:[19]

    "Although the expression "economic substance" may be open to different interpretations, this statement recognizes that the provisions of the Act were intended to apply to transactions that were executed within the object, spirit and purpose of the provisions that are relied upon for the tax benefit."

    …

    "Although the Explanatory Notes make reference to the expression "economic substance", s. 245(4) does not consider a transaction to result in abusive tax avoidance merely because an economic or commercial purpose is not evident.[20]"

    Later in its analysis in Canada Trustco, the Supreme Court stated:

    While the "economic substance" of the transaction may be relevant at various stages of the analysis, this expression has little meaning in isolation from the proper interpretation of specific provisions of the Act. Any "economic substance" must be considered in relation to the proper interpretation of the specific provisions that are relied upon for the tax benefit.[21]

    The Supreme Court's assessment of the role of economic substance in a Back to top

    Penalty

    The proposed amendments include adding a penalty of 25 per cent of the amount of the tax benefit that would have resulted but for the application of the [22] but was never enacted, and the topic has resurfaced from time to time. There are reasonable positions on both sides of the GAAR penalty debate. A naysayer might point out that [23] the Supreme Court recognized three categories of offense, namely, mens rea, strict liability and absolute liability. Under strict liability, doing the prohibited thing attracts a punitive consequence, but defenses lie based on mistaken belief in facts or if reasonable steps were taken to avoid the impugned event. By comparison, there is no defense to an absolute liability offense. Absolute liability is only engaged by express language and mens rea offenses require some degree of intentionality and the elements must be proven by a prosecutor. Otherwise, strict liability may be presumed. Sault Ste. Marie was imported into tax law by Bowman J (as he then was) in Pillar Oilfields[24] as approved of by the Court of Appeal in Consolidated Canadian Contractors.[25] In my view, an implied due diligence defense may be found to the proposed [26] the quantum of a tax benefit in GAAR appeals is rarely, if ever, an issue. However, if a penalty is to be based on the amount of the benefit, we may reasonably expect more taxpayers to focus on and challenge the determination of reasonable tax consequences that would be denied, per s. 245(5).

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    Reassessment period

    The proposals to amend the [27] relates to the "series of transactions" concept. An issue may arise where a series of transactions crosses the effective date of the amendments. The Joint Committee very reasonably asserted that if a series straddles the effective date, then it should not be subject to an amended GAAR. This concern is amplified in light of the potential application of penalties and the unfairness that would result if taxpayers could be penalized for not complying with law at a time when the law was not yet in force.

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    Concluding thoughts

    Other commentators have observed that the proposed amendments are a solution to a non-existent problem, or predicated on the assumption that if the Crown ever loses a case it must be because of a deficiency in the law, so the law must be changed to ensure the Crown never loses. Without wishing to sound too strident, a critic might say that in other areas of law, contentious cases can go either way, and parties have to live with the results. Further, in the case of Crown litigation, the odds are already stacked, insofar as nobody has deeper pockets or greater patience than the government of Canada which, it has to be noted, makes the laws and also has the largest law firm in the country at its disposal to enforce them.

    If a party like a regulator wins every case, one might wonder if they are cherry-picking winners and whether they ought to try more borderline cases. Avoiding cases that could go either way may leave "money on the table", but pursuing such cases comes with litigation risk. A mature view is that this kind of risk comes with the territory.

     

    [1] David A. Dodge, "A New and More Coherent Approach to Tax Avoidance" (1988) 36:1 Canadian Tax Journal 1-22, at 9.

    [2] The General Anti-Avoidance Rule, Past, Present and Future, Brian Arnold ed., Canadian Tax Foundation, 2010, at p. 23.

    [3] Deans Knight Income Corp. v. Canada, 2023 SCC 16.

    [5] R.S.C., 1985, c. I-21, s. 13.

    [6] Readers with a keen interest in preambles may enjoy the following journal article: https://lawjournal.mcgill.ca/wp-content/uploads/pdf/8178207-47.1.Roach.pdf.

    [7] Recall that the Explanatory Notes to the 1988 legislation that included the GAAR clearly distinguished between misuse of specific provisions and abuse of the ITA read as a whole (at p. 465). However, the courts have read misuse and abuse together.

    [8] Canada v. Alta Energy Luxembourg SARL, 2021 SCC 49.

    [9] Lipson v. Canada, 2009 SCC 1.

    [10] Lehigh Cement Limited v. Canada, 2010 FCA 124.

    [11] Canadian International Tax Developments, presented at the IFA Canada International Tax Conference, May 16/17, 2023, Calgary, Alberta.

    [12] Canada v. Spruce Credit Union, 2014 FCA 143.

    [13] Some argue that substance may prevail over legal form in certain instances, for example, in the application of s. 84(2) of the ITA.

    [14] Stubart Investments Ltd. v. The Queen, [1984] 1 SCR 536.

    [15] Jacques Sasseville, "Implementation of the General Anti-Avoidance Rule" in Income Tax Enforcement, Compliance, and Administration, 1988 Corporate Management Tax Conference (Toronto: Canadian Tax Foundation, 1988), 4:1-16. In fact, at p. 576 of Stubart, the Supreme Court spoke of an interpretive test that would allow the ITA to address the conduct of taxpayers that seeks to defeat the express intention of Parliament – conduct that falls within the object and spirit of the relevant provisions. That interpretive test was the "modern rule" of statutory interpretation. Where Stubart and the GAAR may differ is that Stubart rejected the "business purpose" test as a doctrine that would allow the CRA (or its predecessors) to disregard the tax results of transactions that lack a business purpose independent of tax savings. Although the Sasseville paper disputes this, noting that the Supreme Court stated in Stubart that former s. 245(1) may be applicable where the facts of a case reveal no business purpose, depending on the circumstances.

    [16] Sasseville, supra note 15.

    [17] Dodge paper, supra note 1.

    [18] For example, loss consolidation within a related group is a strategy that may lack "economic substance" while also not being expressly blessed by the ITA. In fact, efforts to enact a group taxation regime have failed. And yet, loss consolidation transactions that comply with the provisions of ITA are not ordinarily GAAR-able.  

    [19] Canada Trustco Mortgage Co. v. Canada, 2005 SCC 54.

    [20] Ibid, at paragraphs 56 and 57.

    [21] Ibid, at paragraph 76.

    [23] R. v. Sault Ste. Marie, [1978] 2 SCR 1299.

    [24] Pillar Oilfield Projects Ltd. v. The Queen (1993), 2 GTC 1005.

    [25] Canada (Attorney General) v. Consolidated Canadian Contractors Inc. (C.A.), [1999] 1 FC 209.

    [26] Brian Arnold, The Arnold Report #256, April 19, 2023.

    [27] Dated June 7, 2023.