The Income Tax Act aims to tax people, companies, trusts, and anyone else who earns income through an economic activity. Every transaction can be viewed in the light of economics. For instance, when you buy a mobile phone for personal use, you pay GST, and the seller pays corporate tax. If you purchase a phone for work, you can claim it as an asset, apply capital cost allowance, and deduct GST paid from your GST bill.
The Concept of Tax Avoidance Transactions
A simple transaction like buying a phone has economic relevance, and the main objective is not to avoid tax but to buy an asset for personal or business use. However, taxpayers can get creative and undertake transactions that comply with the Income Tax Act, with valid documentation, tax deductions, and benefits. However, such transactions intend to avoid taxes rather than economic purposes. Such transactions misuse or abuse the Income Tax provisions to avoid taxes. They were challenging to identify, and the penalty was not stringent. However, this has changed with implementing the new general anti-avoidance rule.
Changes in the General Anti-Avoidance Rule
On June 20, 2024, changes to the general anti-avoidance rule (GAAR) received royal assent. The New GAAR applies to transactions that occur on or after January 1, 2024. However, the penalties would only apply to transactions occurring after June 20, 2024, when the bill received royal assent.
Why does that matter? Before the changes were implemented, if any transaction fell under GAAR, the repercussion was a denial of any tax benefit the taxpayer received on that transaction, making the taxpayer pay the additional tax.
A Penalty for GAAR Reassessments
However, the new GAAR rules have introduced a penalty of 25% on the extra tax charged if the CRA catches GAAR transactions. The taxpayer has to pay the additional tax and a 25% penalty. However, no penalty will apply if the taxpayer voluntarily discloses the GAAR transactions before the CRA finds them. The taxpayer only has to pay the additional tax.
Broader Scope of Tax Anti-Avoidance Transactions
For a transaction to be caught as GAAR, it must first be classified as an avoidance transaction. Previously, for a transaction to be classified as GAAR, the purpose of the transaction should be tax avoidance. Hence, many transactions that avoided taxes and had a “bona fide purpose” (a genuine business reason such as creditor-proofing or restructuring) escaped CRA’s claws.
The new rule has also expanded the definition of an “avoidance transaction.” It now includes transactions that have a bona fide purpose, but among the primary purposes is to obtain a tax benefit. The restructuring and other transactions that earlier escaped GAAR because of the Bonafide purpose could now fall under the definition of an “avoidance transaction.” Under the new law, proving the bona fide purposes may not be enough to drop out of the GAAR.
Economic Substance Test
Once the CRA categorizes the transaction as an avoidance transaction, it will run it through an economic substance test introduced under the new GAAR.
If the tax benefit from the transaction is more than the non-tax return, the CRA has reasonable grounds to believe that the transaction was undertaken to avoid taxes. Such tax avoidance transactions are frequently seen in reorganizations of corporations and personal estates.
This means the CRA could still come after you, even if you have followed all regulations provided they find any tax avoidance transactions.
The new rules have extended the standard reassessment period for transactions subject to the GAAR by three years. Such transactions will be taken to court, where judges will determine if new GAAR rules apply and how.
What Should Taxpayers Do?
It will take time to understand the extent and range of updated rules. The CRA is releasing guidance to explain the application of new GAAR rules. It has suggested that the GAAR may not apply to common estate plans, such as an estate freeze, in certain circumstances.
People and companies should follow the rule changes and enter tax planning transactions cautiously. Any transaction that saves or defers tax or increases tax refunds should be viewed critically from the GAAR lens.
Contact Glenn Graydon Wright LLP in Oakville to Help You with Tax Planning
A tax professional can help you navigate the rule changes. If the CRA knocks on your door, they are well equipped to represent you in the judicial court. At Glenn Graydon Wright LLP, our tax consultants can provide tax planning and filing services. To learn more about how Glenn Graydon Wright LLP can provide you with the best tax expertise, call us today at 905-845-6633 or online to schedule an initial consultation.