What is GAAR?

Written by Mark R. Servello, CPA, CGA, Kenway Mack Slusarchuk Stewart LLP

GAAR stands for the General Anti-Avoidance Rule.

The GAAR rules were added to the Income Tax Act (“the Act”) in 1988 to prevent abusive tax avoidance transactions while not interfering with legitimate transactions.  In Finance Canada’s 2022 consultation paper on GAAR it was stated that GAAR was intended to strike a balance between taxpayers’ need for certainty in planning their affairs, and the government’s responsibility to protect the tax base and the fairness of the tax system.

Included in the 2023 Federal Budget were proposed changes to the GAAR rules.  The new GAAR rules apply to transactions that occur on or after January 1, 2024.

In order for GAAR to apply, there must be an avoidance transaction in the first place. That has not changed under the new GAAR rules, but what has changed is the test to determine whether a transaction is an avoidance transaction.  Under the new GAAR rules, if a transaction or part of a series of transactions results directly or indirectly in a tax benefit, the transaction will fit into the new test for avoidance transaction unless it may be reasonably considered that obtaining the tax benefit is not one of the main purposes for undertaking or arranging the transaction.

If a transaction is an avoidance transaction, GAAR will apply to the transaction only if it may be reasonably considered that either:

1. the transaction would result directly or indirectly in a misuse of any one or more of the Act, the Income Tax Regulations, the Income Tax Application Rules, a tax treaty, or any other enactment that is relevant in computing tax or any other amount payable by or refundable to a person under the Act or in determining any amount that is relevant for the purposes of that computation; or
2. the transaction would result directly or indirectly in an abuse having regard to those provisions read as a whole.

The wording of the misuse or abuse test has not changed under the new GAAR rules, but Finance Canada has added a new provision related to economic substance under the new GAAR rules. It basically states that if an avoidance transaction, or a series of transactions that includes the avoidance transaction, is significantly lacking in economic substance, this is an important consideration that tends to indicate that the transaction results in a misuse or abuse.

The new GAAR rules also contain a new penalty.  Under the old rules, if GAAR was successfully applied, the tax benefit which was a result of the avoidance transaction was denied, essentially putting the taxpayer back to the initial position as if there had been no tax planning done to achieve the tax benefit in the first place.  Under the new GAAR rules, if GAAR is successfully applied, the taxpayer is still put back to the initial position as if there had been no tax benefit and, in addition, a new 25% penalty will apply on the amount of the tax benefit the taxpayer was seeking to achieve.

The new GAAR penalty applies to transactions which occur on or after June 20, 2024 (the date on which the Bill that included the new GAAR rules received Royal Assent).

There are two exceptions to the new GAAR penalty:

1. The penalty will not apply to a person in respect of a transaction if the person demonstrates that, at the time the transaction was entered into, it was reasonable for the person to have concluded that GAAR would not apply to the transaction in reliance on the transaction or a series that includes the transaction being identical or almost identical to a transaction or series that was the subject of
   1. published administrative guidance or statements made by the Minister or another relevant government authority; or
   2. one or more court decisions.
2. The penalty will not apply if the transaction is disclosed to Canada Revenue Agency (“CRA”) in a timely manner.

Another change that is part of the new GAAR rules is if a taxpayer does not voluntarily disclose a transaction to CRA in a timely manner, CRA has an additional three years beyond the normal reassessment period to reassess under GAAR.

If you are involved in a transaction where you are obtaining a tax benefit, do not hesitate to ask your advisor if there is any potential GAAR risk to the transaction.

In some cases, your advisor may be able to tell you that there is no GAAR risk or the GAAR risk is very low because perhaps the tax benefit you are obtaining is a tax benefit that has been contemplated by Parliament.

In other cases, the determination of the amount of GAAR risk may not be straight forward and may require a detailed analysis of the legislation, published administrative guidance, and court decisions.

Conclusion

The new GAAR rules are much broader than the old rules and can potentially apply to any transaction or part of a series of transactions that result in a tax benefit, which was not contemplated by Parliament and which fits into the new avoidance transaction test, if the transaction may reasonably be considered to result in a misuse or abuse of the Act or other applicable legislation listed above.

Please contact your local DFK advisor if you would like to discuss how the new GAAR rules may affect your future tax planning.