Rule: Canadians must tax plan now! It is absolutely essential that small business owners in Canada tax plan now. Why you may ask? Because Section 245 of the Income Tax Act could end up costing the owner literally millions because it allows the Canada Revenue Agency to cancel last minute tax planning.
A small business owner in Canada works hard to build up wealth over numerous years. One day they may receive an offer to sell. They call their accountant who then replies, “Sorry, Section 245 stops you from doing planning. You will have to pay the tax. I wish you called me last year, I could have saved you about a million.” And the same bad consequence occurs in an early death of the Owner.
Before you panic, the lesson is clear from the accountant. If the Owner had planned during the lifecycle of their business, such as getting an STA tax plan: they could have created and implemented a legal tax plan. Legal planning in the lifecycle of a business is not affected by Section 245 (GAAR).
The GAAR was promulgated in 1988 as an aftermath of the decision of the Stubart Investment case of the Supreme Court of Canada. The phenomenon of tax avoidance is a legal means to bypass paying taxes and utilizing the tax law for personal gains such as reducing the amount of tax being paid or simply looking for exemptions in the tax laws. This is specifically different to tax evasion which is an illegal method to avoid taxes. The GAAR discourages this type of tax avoidance in which provides companies a tax advantage in case a transaction is willfully done in order to take advantage of tax laws.
The GAAR under section 245 of the Income Tax Act is a provision that allows the Canada Revenue Agency (CRA) to explore and identify the purpose of impugned transactions that are used specifically to take advantage of the tax law and as a consequence avoid paying taxes. There exists a whole department in the CRA dedicated to this one section of the Act, and there are specific investigators who deal only with this section.
Admittedly, many entities have vigorously explored the opportunities to maneuver around relevant sections of the Income Tax Act. Ther GAAR clearly imparts extra powers to enable the Federal Government to scrutinize strategic transactions which may in some sort be abusive to the spirit of the tax laws. The main postulate of the rule is the section 245 (2) which states that if any transaction is classified or assessed to be an avoidance transaction, the CRA must deny the tax benefit obtained from that transaction. And when peple ask me what is abusive to the spirit of tax laws, I reply: “It is the sum of the decisions and rulings of every single tax case in Canada.”
But I shall try to explain the rule: The CRA has to evaluate the questioned transaction against the following three tests in order to be able to reassess the taxpayer. The taxpayer must have enjoyed tax benefits based on impugned transactions. Also, the taxpayer must have used an avoidance strategy Section 245 (3) clearly states that if the transaction does not appear to be coming as a natural consequence, it clearly reflects the intention for tax avoidance. This step provides taxpayers a chance to challenge the judgment of the assessing authorities.
During the last phase, the investigators must assess if the taxpayer is involved in abusive tax avoidance. This phenomenon points towards determining if the taxpayer is involved in a series of transactions or arrangements that are utilized to circumvent the application of various provisions of the law. However, there is a defense to the taxpayer, if it would be reasonable to conclude that there was no abuse provided the avoidance transaction was within the spirit of the provisions that confer the tax benefit.
The GAAR exists in the tax law in order to ensure that there is sufficient room for authorities to bring certain entities under the ambit of the tax regime who willfully use a transaction or a series of transactions as a tool of deceit. Under such circumstances, it would be expedient to distinguish if the transaction is an avoidance tactic based on the ill intent of the entity or comes as a natural consequence of a business transaction. It must be noted that a transaction is an avoidance transaction only if it is used to avoid paying a tax which would otherwise be applicable on the entity.
The GAAR does not apply to a transaction which does not result in the misuse of the provisions of the tax law. Also, it would not be applicable in circumstances where tax planning is carried out in coherence with the spirit of the provisions of the underlying provisions of the law which allow such a benefit to be taken. This is why working with experienced tax practitioners such as STA is a must.
In order to understand the spirit of the tax laws, in is expedient to note the consequences of a certain transaction for an entity. Some examples of tax consequences are the deemed amount of taxable income, the net income or losses in order to arrive to the minimum tax amount, the paid up capital amount for the computation of capital tax, computation of gross premium amounts in case of premium taxes and contributions to the benefit plans. The section 245 clearly targets only those transactions that have a tax consequence for an entity.
The Section 245 also provides for the retrospective reassessment of tax liability if it is established that the avoidance transactions have been carried out. This gives more flexibility to the assessors who can make amends in case they find a continuing tax avoidance strategy over the period of users by an entity. All such cases would be notified to the entity concerned by means of assessment or reassessment. However, in certain circumstances, there is a chance that the consequence of tax avoidance may be realized in the coming year. In such cases, an assessment cannot be made and the corporation or entity under scrutiny would be issued a letter of determination in place of assessment.
The GAAR has been severely castigated for bringing in more uncertainty. Critics have opined that it also gives room for discretion by the tax assessors who may on the basis of a mere conjecture or personal biasness wrongfully adjudge the entity to be guilty of using the tax avoidance strategy. They have also called for a comprehensive guideline to be issued for the exercise of powers conferred under this rule. Although, the Rule clearly elucidates broad criteria under which it is applicable, a more comprehensive guideline covering may industry specific issues is needed.
An abuse of the Section 245 exists if the relationships and transactions expressed in the relevant documentation are inconsistent with the object and nature of the activities of the business as well as not in the spirit of the provisions that impart the tax benefit. The only concern about this clause is that it is overly reliant on the judgment of the tax authorities and does not provide any clear guidance on the implementation of the rule.
Moreover, with the GAAR one must consider the economic benefits in an avoidance transaction. Unless the reviewed transaction clearly reflects the economic benefits in the transaction, it may be regarded as an avoidance transaction. Determining the primary purpose of the transaction and its economic benefits are therefore essential in deciding whether a particular transaction is an avoidance transaction or not.
Although the GAAR is intended to cover the concerns of the Federal Government of inadequate cover against tax avoidance, it has not been welcomed by the corporations who deem it to be heavily biased against the taxpayer who fear both harassment as well as economic consequences as a result of this rule. Taxpayers have called for a more adequate disclosure policy rather that imposition of an anti-avoidance rule.
The problem with the GAAR has been its acceptability and implementation issues in the court of law. This brings into question the effectiveness of the law. However, its application as been upheld in lower courts after cases heard at the Supreme Court went in favour of the GAAR. However, critics have maintained that in many cases where the GAAR has been upheld, the matter could have been decided in favor of tax authorities even if the law was not present at all therefore undermining the importance of the GAAR.
Again the lesson is clear with the GAAR. If the owner had planned during the lifecycle of their business, such as getting an STA tax plan: they could have created and implemented a legal tax plan. Legal planning in the lifecycle of a business is not affected by Section 245, the Canadian Anti-Avoidance Rule. STA tax welcomes inquiries about all tax inquiries. Working together with its’ valuation partner VAS: it can easily be a million dollar decision. STA can also provide advice on proposed transactions through its Transactional Tax Planning (TTP) department.
And for my American readers, there is no statutory GAAR in the United States of America.