The government declared that Federal Budget 2021 ("Budget 2021") is about finishing the fight against COVID-19 and creating prosperity for Canadians in the decades to come. Supporting this stated objective are new and enhanced tax administration and enforcement measures targeted at increasing tax revenues, including strengthening mandatory disclosure rules, proposed new measures to combat international tax avoidance, tackling tax evasion, aggressive tax avoidance and schemes to avoid collections, as well as enhanced Canada Revenue Agency ("CRA") audit powers.
Mandatory disclosure rules
Budget 2021 cites a lack of timely information concerning so-called aggressive tax planning as a major challenge for tax administrations. The government's lack of success in its existing legislative and litigation agendas, which were undertaken to peel back the tax planning curtain, likely informed the disclosure rule proposals in Budget 2021. Comments on the proposals may be directed to the Department of Finance by September 3, 2021 for their consideration.
Reportable transactions
Canada's reportable transactions regime was introduced in Budget 2010 and set out a requirement to report certain transactions where two out of three generic "hallmarks" (known as the fee, confidential protection and contractual protection hallmarks) were present. The definition of a reportable transaction relied on the general anti-avoidance rule concept of an avoidance transaction. Details about compliance have been scarce and the CRA has refused to fulfill requests under the Access to Information Act for data. Anecdotally, the existing reportable transactions regime appears to have failed and Budget 2021 concedes that these rules resulted in limited filings, hence the impetus to amend.
Proposed changes are:
(1) Only one rather than two of the three generic hallmarks need to be present for a transaction to be a reportable transaction;
(2) The definition of "avoidance transaction" for the purposes of the regime would be materially broadened to include a scenario in which it may be reasonably concluded that one of the main purposes of entering into the transaction was to obtain a tax benefit;
(3) The timing for filing a report would be dramatically shortened, from June 30 of the year following the year of the transaction to within 45 days of the earlier of two triggering events; and
(4) Reporting would be required by promoters or advisors, in addition to taxpayers and persons entering into transactions to benefit taxpayers (subject to solicitor-client privilege).
Notifiable transactions
While the reportable transactions regime targets generic hallmarks of so-called "aggressive tax planning", Budget 2021's notifiable transactions regime would target specific areas of concern (e.g. loss trading). The proposed rules would be analogous to the US "listed transactions" and "transactions of interest." The proposed Canadian regime would allow the Ministers of Revenue and Finance to designate notifiable transactions, which would be those that have been found to be abusive, and transactions "of interest." Descriptions would be provided of factual scenarios and outcomes, including specific, detailed examples as appropriate to assist taxpayers with identifying notifiable transactions.
Budget 2021 proposes that a notifiable transaction (or one that is substantially similar to a notifiable transaction) be reported to the CRA in prescribed form within 45 days. The reporting requirement would apply to taxpayers who enter into notifiable transactions, other persons who enter into such a transaction to obtain a benefit for a taxpayer, and promoters/advisors and persons operating not at arm's length with promoters/advisors who are entitled to transaction fees. Again, an exception would apply where advice was subject to solicitor-client privilege.
Reporting uncertain tax positions
An uncertain tax position ("UTP") is a tax filing position the sustainability of which is open to enough doubt that a reserve is required to be recorded on financial statements prepared in accordance with IFRS (required for public corporations and optional for private corporations). Budget 2021 proposes that UTPs be reported to the CRA in certain circumstances, namely, where the corporation:
(1) Is required to file a Canadian return of income;
(2) Has at least $50 million in assets at the end of the year (based on carrying value on the corporation's balance sheet or that would have been reflected on the balance sheet had one been prepared in accordance with GAAP; for banks and insurers, the relevant amount would be as disclosed for regulatory purposes);
(3) Has audited financial statements prepared in accordance with IFRS or another form of country-specific GAAP relevant for domestic public companies (including related corporations); and
(4) Reflects some uncertainty in its audited financial statements in respect of its filing position (i.e. it is more likely than not that the domestic tax authority would not entirely accept the filing position).
The reporting requirement would extend to corporations that are controlled by Canadian public corporations that meet the reporting thresholds.
The reporting of prescribed information (being the quantum of tax, relevant facts, tax treatment including specific ITA provisions, and whether the UTP concerned temporary or permanent differences) would be required contemporaneously with the corporation's T2 filings. While the proposed regime does not overturn the result in the Federal Court of Appeal ("FCA") decision in BP Canada Energy Company v. Canada (National Revenue), the utility of UTPs to formulate audit strategy was squarely framed in that case and that loss was likely frustrating for the CRA.
Extended reassessment period and penalties
Budget 2021's rationale for requiring potentially abusive transactions to be proactively reported to the CRA, and on shortened timelines, is fairly obvious. A taxation year in which a well-planned and executed transaction was implemented will become statute-barred in three or four years unless an exceptional extended limitation period is engaged. Budget 2021 proposes to further enhance the CRA's audit powers by providing for the suspension of the normal reassessment period where a taxpayer failed to adhere to its mandatory disclosure requirements under the above regimes.
Finally, Budget 2021 proposes a penalty regime where a taxpayer that fails to meet reporting requirements for reportable or notifiable transactions would be subject to a $500 per week penalty, capped at the greater of $25,000 and 25% of the tax benefit achieved. For corporations with assets of $50 million or more, the penalties quadruple. Promoters/advisors and people operating not at arm's length with promoters/advisors and who are entitled to fees in respect of transactions may have penalties imposed equal to: 100% of their fees in connection with the tax benefit; $10,000; and $1,000 per day for each day the failure persists to a maximum of $100,000. Corporations that fail to report UTPs would be subject to a penalty of $2,000 per week to a maximum of $100,000.
International tax measures - Review of transfer pricing rules
Budget 2021 reiterated the government's commitment to safeguarding Canada's tax system and its continued cooperation with the OECD in addressing base erosion and profit shifting ("BEPS"). BEPS primarily refers to international tax planning arrangements used by multinational enterprises to reduce their taxes by, for example, shifting profits earned in Canada to lower tax jurisdictions. One of the key defences for a government to combat BEPS is to ensure it has an effective transfer pricing regime. Although the OECD has, through its BEPS project, enhanced its international transfer pricing guidelines pertaining to the arm's length principle to address BEPS concerns, the ultimate benefit of the OECD's work will come down to how each country's tax system can successfully adhere to the OECD transfer pricing guidelines.
In Canada, the effectiveness of the OECD's transfer pricing guidelines, as well as Canada's transfer pricing rules in general, in combating BEPS has come under scrutiny in light of some recent court decisions, especially the FCA decision in Her Majesty the Queen v Cameco Corporation ("Cameco") (leave to appeal the Cameco FCA decision to the Supreme Court of Canada was denied). The Cameco decision was a significant win for the taxpayer and has seriously impaired the government's ability to apply its transfer pricing recharacterization rules in future cases. To a lesser degree, although the Cameco case dealt with taxation years that pre-dated the post-BEPS revised transfer pricing guidelines, the case also raised issues as to how effective the revised transfer pricing guidelines will be in combating certain aggressive transfer pricing transactions.
As announced in Budget 2021, the Department of Finance will release a consultation paper to provide stakeholders with an opportunity to comment on possible measures to improve Canada's transfer pricing rules. It is anticipated that this consultation paper will not be limited to simply proposed amendments to the recharacterization rules to address the shortcomings brought to light in Cameco. The Canadian transfer pricing community will be anxious to see what the government is considering.
Tackling tax evasion and aggressive tax avoidance
Budget 2021 builds on previous federal budgets to "combat tax evasion and aggressive tax avoidance," by committing an additional $304.1 million over five years, to enable the CRA to fund new initiatives and extend existing programs, including:
- Increasing GST/HST large business audits with high risk of non-compliance;
- Preventing unwarranted and fraudulent GST/HST refund and rebate claims and quickly issuing refunds for proper claims; and
- Enhancing capacity to identify tax evasion involving trusts and provide better service to executors and trustees.
These initiatives are expected to recover revenues of $810 million over five years.
Enhanced collections enforcement
Budget 2021 also proposes to provide an additional $230 million over five years for the CRA to improve its ability to collect outstanding taxes, which is anticipated to lead to the collection of an additional $5 billion in outstanding taxes over five years. One new mechanism to help the CRA's collection efforts seeks to stop abusive tax debt avoidance schemes designed to circumvent the application of an existing tax debt avoidance rule. The current rule makes a non-arm's length recipient of property liable for taxes owing by the transferor of the property who owes tax, up to the FMV of the transferred property, minus the FMV of any consideration given in return (both valuations determined at the time of transfer). In certain circumstances, the rule is now enhanced, for transfers of property that occur on or after Budget Day, to prevent planning to technically avoid the rule by:
- Arranging for a tax debt to crystallize after the end of the taxation year in which the property transfer occurs, by deeming the tax debt to have arisen in the taxation year in which the property was transferred;
- Arranging for the transferor to be dealing at arm's length with the transferee at the time of the property transfer, by deeming them to not having been dealing with each other at arm's length; or
- Stripping out net asset value of the transferor using a series of transactions that does not breach the point-in-time valuation test for the property transferred and consideration given therefor, by determining these values based on the overall result of the series of transactions, rather than simply using the values at the time of transfer.
Planners and promoters of these tax debt avoidance schemes will also face penalties equal to the lesser of:
- 50% of the tax that is attempted to be avoided; and
- $100,000 plus the planner's or promoter's compensation for the scheme.
Enhanced audit powers
Finally, Budget 2021 also proposes to enhance the CRA's audit powers by providing its auditors with the authority to require taxpayers to answer all proper questions and provide all reasonable assistance relating to the administration or enforcement of the ITA, including requiring persons to attend at the place of business and respond to questions in any form specified, whether in writing or orally. This proposal responds to the judgment in Canada (National Revenue) v. Cameco Corporation, which concerned the CRA's efforts to compel 25 employees to attend interviews and answer questions in person. Those efforts were not supportable based on the wording of the statutory audit provisions as they read at the time. By proposing to amend the relevant provisions, the government of Canada may be taken as conceding that its June 3, 2019 communiqué responding to adverse court decisions, "AD-19-02R: Obtaining Information for Audit Purposes", was not compelling.
Conclusion
For many years, the Canadian government has, in successive Budgets, deployed substantial and ever expanding resources, seeking to significantly increase tax revenues, albeit with mixed results. In Budget 2021, the Minister of Finance celebrated a projected federal deficit of $354 billion for 2020/2021, being significantly lower than the government's earlier forecast of the deficit. Only in a COVID-19 world would such an enormous deficit be considered a success. There has rarely if ever been a time when increasing tax revenues has become more urgent and crucial.