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What Canada's new mandatory disclosure rules mean for you

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Attention Canadian business owners, corporate executives, and individual taxpayers engaged in tax planning: The landscape of compliance has shifted dramatically. The enactment of Bill C-47 on June 22, 2023, has ushered in new mandatory disclosure rules in Canadian income tax law.

These rules introduce or amend three categories: Reportable Transactions, Notifiable Transactions, and Uncertain Tax Treatments. Each has specific triggers and reporting obligations. Failure to comply can result in significant penalties, including financial sanctions and extended limitation periods for reassessment by the CRA. Given the complexities and potential repercussions, it is crucial for taxpayers to consult legal professionals to ensure compliance and effective tax planning.

Context

Reportable transaction rules have been a part of Canada’s Income Tax Act (the Act) since 2011.

Previously, the rules mandated reporting in instances where an avoidance transaction—a transaction primarily aimed at securing a “tax benefit,” (as defined) evidenced at least  two out of three specific hallmarks of “aggressive” tax planning. . The hallmarks were:

  • Fees: Circumstances where the fees paid to the tax advisor were based on the benefit of the tax planning strategy, contingent on the strategy’s success, or in some way based on the number of persons benefitting from the strategy.
  • Confidential protection: Situations where the taxpayer was required to keep the information about the strategy confidential.
  • Contractual protection: Strategies where the taxpayer, promoter, or tax advisor received contractual protection in respect of the transaction.

As early as the 2021 Federal budget, an expansion of these rules has been contemplated in response to an increasing number of successful tax planning strategies. Draft legislative proposals were released on February 4, 2022 and August 9, 2022, and Bill C-47 became law on June 22, 2023. 

The New Changes

Bill C-47’s changes to the mandatory disclosure rules fall under three distinct regimes:

  1. Reportable Transactions: These apply to "avoidance transactions" entered into after the date of royal assent (June 22, 2023) that satisfy one of the three specified "hallmarks".
  2. Notifiable Transactions: These apply to transactions based on a resemblance to specifically "designated" transactions, entered into after the date of royal assent (June 22, 2023).
  3. Uncertain Tax Statements: These apply to specific "reporting corporations" who engage in transactions with "uncertain tax treatments" as reflected in their audited financial statements. These rules apply to taxation years that begin after 2022.

These rules modify the pre-existing reportable transaction rules, and introduce new rules governing notifiable transactions and those with uncertain tax treatments. 

Let’s explore each of these in greater detail.

1. Reportable Transactions

Reportability Triggers

The new rules expand the reportable transactions regime. Rather than requiring two of the three hallmarks – as was the case with the old regime – all that is required is that the transaction is an “avoidance transaction” and falls within one of the three “hallmarks.”

For these purposes, an avoidance transaction is one where it may reasonably be considered that one of the main purposes of the transaction, or of a series of transactions of which the transaction is a part, is to obtain a “tax benefit.” However, a transaction will not be reportable simply because it is an avoidance transaction – one of the three hallmarks must also be present. 

The three hallmarks bear great similarity to those previously in force, but what is critical is that now only one of them needs to be present, not two.

The first hallmark, contingent fees, are met when an advisor, promoter, or person that does not deal at arm’s length with an advisor or promoter, is entitled to a fee that is based on the amount of a tax benefit, contingent on achieving a tax benefit, or based on the number of people taking part in the transaction. The standard hourly fee arrangement, or even a flat rate per-transaction fee arrangement, will not trigger this hallmark (provided the fee is not linked to or otherwise contingent on taxes saved).

The second hallmark, confidential protection, is met when an advisor, promoter, or person that does not deal at arm’s length with an advisor or promoter, obtains “confidential protection”, meaning a prohibition on disclosure by the taxpayer of a “tax treatment,” in relation to the transaction or series of transactions This does not apply to solicitor-client privilege obtained through the lawyer-client relationship, which belongs to the client, and is therefore not obtained by the lawyer.

The third hallmark, contractual protection, is met when a taxpayer, advisor, promoter, person who has entered into the avoidance transaction for the benefit of the taxpayer, or someone who does not deal at arm’s length with any of these, receives contractual protection regarding the avoidance transaction. This is broad in scope, and includes things that protect the taxpayer from the failure of the transaction to obtain the desired tax benefit. It is envisioned to include insurance, indemnities, or other guarantees, as well as various forms of compensation. Notably, it does not include standard professional liability insurance, or protections where it is reasonable to consider that the protection (e.g. indemnity) is intended to ensure that the purchase price paid under the agreement takes into account any liabilities of the business immediately prior to the sale or transfer and obtained primarily for purposes other than to achieve any tax benefit from the transaction or series. This generally excludes from this hallmark those indemnities ordinarily given in the course of a commercial transaction between arm's length parties.

Further CRA guidance has clarified that the third hallmark does not include standard representations, warranties, and guarantees between a vendor and purchaser; standard price adjustment clauses; and contractual protection involving insurance essential to a business sale agreement between independent parties, aimed at adjusting the purchase price for pre-existing liabilities and primarily serving non-tax-related purposes.

Who Needs to Report

Reporting obligations are not confined exclusively to the taxpayers who obtains the tax benefit. The following parties must report:

  1. The person for whom a tax benefit arises, or is anticipated to arise, from a reportable transaction or a series that includes such a transaction, based on their tax treatment of it.
  2. Parties engaged in an avoidance transaction that qualifies as a reportable transaction, undertaken for the benefit of the person specified in (A).
  3. Under specific conditions, advisors and promoters are required to report, particularly those who earn fees contingent on the transaction's success or provide contractual protection.

How to Report

Persons who report must do so using the prescribed form, Form RC312, which can be found here. It is important to note that each person relevant to a transaction must complete its own reporting. It is not sufficient for one party to report on the behalf of others (e.g. for a taxpayer to report on behalf of an advisor). 

When to Report

The deadline for submitting an “information return” to disclose a reportable transaction is typically set at 90 days. This period commences either when a relevant person is contractually bound to engage in the reportable transaction or actually enters into it, whichever occurs first. For a series of transactions that spans across June 22, 2023, the Canada Revenue Agency's guidance specifies that the 90-day window generally starts from the date of the initial transaction in the series that takes place on or after that date.

Penalties for Failure to Report

There are three main consequences of failing to report:

  1. Substantial Penalties: The failure to report a notifiable transaction could incur severe financial repercussions, including a penalty that may reach up to 25% of the tax benefit derived from the transaction. However, persons who can demonstrate that they acted with due diligence in their reporting efforts are exempt from such penalties.
  2. Reduced Threshold for GAAR Application: If a person who gains or is expected to gain a tax benefit fails to meet the reporting requirements and incurs a penalty (or interest on that penalty), the General Anti-Avoidance Rules (GAAR) is to deemed to apply whether the misuse or abuse test under s. 245(4) of the Act is met. This means all that is required for GAAR to apply is for there to be a tax benefit that stems from an avoidance transaction (an already lowered threshold, as discussed here. This is the case until and unless the transaction is reported and any resulting penalties are paid, at which time the standard GAAR test is reinstated.
  3. Extended Limitation Periods: The “normal reassessment period” for a taxpayer concerning a reportable transaction does not commence until the transaction has been duly reported. Moreover, the CRA retains an unlimited time frame to reassess the tax consequences of reportable transactions where there was non-compliance with reporting obligations.

2. Notifiable Transactions

Brand new to the Canadian tax world is the concept of notifiable transactions. Under these regulations, the Minister of Finance has the discretion to designate specific types of tax planning arrangements as subject to new reporting requirements. Failure to adhere to these reporting obligations will result in significant penalties and an extension of the normal reassessment period. The idea is that the transactions that are classified as notifiable by the Minister of Finance will be those that have been determined by the CRA to be of concern or potentially “abusive” in nature.

Notifiability Triggers

A "notifiable transaction" is defined as a transaction, or a transaction within a series, that is the same as or substantially similar to a transaction or series designated as notifiable by the Minister of Finance. Substantial similarity will be found where the transaction is factually similar or based on the same tax strategy and gives rise to the same or similar tax consequences. However, this definition is not exhaustive. The Act additionally stipulates that the phrase "substantially similar" should be construed in a manner that leans towards disclosure. Of course, as with any test that relies on substantial similarity, there is an element of subjectivity that must be recognized, and can lead to uncertainty.

On November 1, 2023, the Minister of Finance unveiled a list of notifiable transactions which are on their website. The list is available online here. In short, the transactions are as follows:

  • Straddle loss creation transactions using a partnership; -
  • Avoidance of deemed disposal of trust property;
  • Manipulation of bankrupt status to reduce a forgiven amount in respect of a commercial obligation;
  • Reliance on purpose tests in section 256.1 to avoid a deemed acquisition of control; and
  • Back-to-back arrangements.

A transaction becomes a notifiable transaction if it is the same or substantially similar to one of these, designated by the Minister of National Revenue with the concurrence of the Minister of Finance, as outlined under section 237.4 of the Income Tax Act.

Who Needs to Report

Generally, the obligation to report a notifiable transaction falls upon the following categories of persons: 

  1. Persons for whom a “tax benefit” results, or is expected to result based on their tax treatment of the notifiable transaction, from either the notifiable transaction itself or a series that includes the notifiable transaction.
  2. Persons who enter into the notifiable transaction for the benefit of a person described in the first category.
  3. Advisors and promoters in respect of the notifiable transaction.
  4. Persons not dealing at arm's length with an advisor or promoter and who are entitled to a fee in respect of the notifiable transaction.

It is important to note that each person relevant to a transaction must complete its own reporting. It is not sufficient for one party to report on the behalf of others (e.g. for a taxpayer to report on behalf of an advisor).

A person who obtains a tax benefit and any other person who enters into the notifiable transaction for the benefit of such a person are not required to report if, after exercising a reasonable degree of care, diligence, and skill, they determine that the transaction is not a notifiable transaction. According to the CRA, this due diligence requirement is met by asking advisors about potential reporting obligations arising from the transactions.

Further, advisors and promoters, along with persons not dealing at arm's length with them, are only required to report if they know or it is reasonable to expect them to know that the transaction was a notifiable transaction. Lack of tax knowledge is not a way out of this criterion. The CRA believes that an obligation to report is generally triggered if the advisor is aware of the purpose and objectives of the transaction while playing a leading role in its implementation. Information reasonably believed to be subject to solicitor-client privilege does not need to be disclosed, affecting the reporting obligations of advisors who are lawyers. It is also worth noting that, as will be discussed shortly, the reporting obligations of lawyers are being contested by the Federation of Law Societies.

Persons who only provided clerical or secretarial services in relation to the notifiable transaction are exempt from the reporting requirement.

How to Report

To report a notifiable transaction, persons must use the prescribed form, which is an information return, being Form RC312, the same form as for reportable transactions, which can be found here. The report should include the reasons for the disclosure, in brief, generally entailing a description of the transaction or series thereof.

If a transaction is both notifiable and reportable concerning the same “tax benefit,” disclosing the notifiable transaction in the same form is adequate to fulfill both reporting obligations. The legislation stipulates that when multiple transactions, or all transactions in a series, are notifiable and subject to disclosure requirements, a person has the option to report each transaction within that series in a single information return. Importantly, note that this consolidated reporting cannot be considered as an admission that any transaction is part of the same series of transactions.

When to Report

The deadline for submitting an information return to disclose a notifiable transaction is typically 90 days. This 90-day period commences either when a relevant person is contractually obligated to engage in the notifiable transaction or when they actually enter into the notifiable transaction, whichever occurs first.

Consequences of Failure to Report

For persons who are obligated to report and fail to do so, the penalties are as follows:

  • A fine of $500 per week for each failure to report, up to the greater of $25,000 and 25% of the "tax benefit"; or
  • For corporations possessing assets with a total carrying value of $50 million or more, the penalty is $2,000 per week, up to the greater of $100,000 and 25% of the tax benefit.

For advisors and promoters involved in notifiable transactions, as well as persons not dealing at arm's length with them who are entitled to a fee concerning the notifiable transaction, and who fail to report it, the penalty for each failure to report is:

  • 100% of the fees charged for the transaction;
  • A flat fine of $10,000; and
  • An additional $1,000 for each day the failure to report persists, capped at $100,000.

Furthermore, similar to reportable transactions, the normal reassessment period for a taxpayer in relation to a notifiable transaction does not begin to run until the transaction has been reported. This means that the tax year in question will not become statute-barred. Additionally, there is no limitation period on the CRA's authority to impose a penalty for failure to file.

3. Uncertain Tax Treatments

Another new addition to the Act is the rules regarding uncertain tax treatments. According to these rules, certain corporations are now required to report any uncertain tax treatments (UTT) to the Canada Revenue Agency (CRA) when they file their corporate tax returns.

Who Needs to Report

These UTT rules apply to corporation that are considered to be “reporting corporations.” Corporations are “reporting corporations” if they meet each the following requirements:

  • The corporation either has audited financial statements for the year, or is part of a consolidated group that has such statements, prepared in accordance with either International Financial Reporting Standards (IFRS) or other country-specific generally accepted accounting principles that are relevant for corporations listed on a stock exchange outside of Canada, such as US GAAP; and
  • The carrying value of the corporation's assets is equal to or exceeds $50 million at the year's end; and
  • The corporation is required to file a Canadian income tax return.

The UTT rules differ significantly from the reportable transaction and notifiable transaction rules in that only the reporting corporation itself is subject to the reporting requirements under the UTT rules; advisors or other third parties are not obligated to report.

UTT Reporting Triggers

Under the rules for UTTs, a "reporting corporation" is obligated to disclose a "reportable UTT." A "reportable UTT" refers to a tax treatment used or planned to be used in the corporation’s income tax filings, and for which there is uncertainty noted in the corporation's audited financial statements for that year. This includes similar uncertainty for groups which the corporation is a member of. This also encompasses the corporation's choice to omit a specific amount from its tax filings. The CRA has specified that reporting corporations are expected to disclose reportable UTTs in respect of their partnership interests.

 The CRA has further confirmed that only UTTs pertaining to provisions of the Act need to be reported. UTTs related to other forms of taxation, such as Goods and Services/Harmonized Sales Tax, provincial taxes, or taxes outside of Canada, are not subject to reporting under these specific rules.

Being Challenged

On September 11, 2023, the Federation of Law Societies of Canada filed an application in the British Columbia Supreme Court, contesting the constitutionality of the amendments' compulsory reporting requirements as they impact legal professionals. The Federation argues that mandating lawyers to report client activities to a government agency conflicts with the duties of loyalty and confidentiality that lawyers owe to their clients. Additionally, these changes pose questions regarding the scope of solicitor-client privilege. 

Since the filing of the application, the Federation has negotiated a consent injunction suspending the application of the challenged provisions to lawyers and articling students in all provinces and territories.  The injunction will remain in place until earlier of the Court’s decision on the injunction application or November 20, 2023.  A hearing on the application for an injunction has been set for October 20, 2023.

Takeaways

The Royal Assent of Bill C-47 has introduced significant changes to Canada's Income Tax Act in the realm of mandatory disclosure rules. These changes are organized into three distinct regimes: Reportable Transactions, Notifiable Transactions, and Uncertain Tax Treatments. Each regime has its own criteria for what must be reported, who bears the reporting obligation, and the deadlines for such reporting. The penalties for non-compliance include substantial financial penalties and an extension of the subject taxpayer’s normal reassessment period. Given the complexity of these new rules and the severity of the penalties for non-compliance, it is imperative for taxpayers to seek professional advice. 

Fillmore Riley LLP's Taxation Practice

We offer tax advice to both individual and business clients on a wide range of matters, including corporate and commercial transactions, estate planning, and tax dispute resolution and litigation. For more information, or if you have any questions, please contact a member of the Fillmore Riley Taxation practice.

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