The government is proposing new disclosure rules that may discourage taxpayers from carrying out certain aggressive tax planning. Under Section 237.4 of the Income Tax Act, the CRA has the authority to designate transactions that taxpayers, advisers, and promoters must disclose to the CRA in a form. These transactions are referred to as “notifiable transactions.” These disclosure rules are meant to reduce a taxpayer’s appetite for aggressive tax-planning schemes. These disclosure rules would also assist CRA in identifying aggressive tax plans.
Below are some of the aggressive tax planning that CRA will require taxpayers and their advisors to disclose.
Manipulating CCPC status to avoid anti-deferral rules applicable to investment income
The corporate tax rates are generally lower than personal tax rates. Because of this, the income tax act has rules to prevent individuals from earning passive income inside Canadian-controlled private corporations (CCPCs). As a result of these “anti-deferral” rules, passive income like dividends, interest, rents, royalties, and capital gains are generally subject to a high corporate tax rate meant to mimic the top marginal personal tax rate.
Example
Suppose Jenny is a high net-worth individual. She incorporates a Canadian corporation and earns $1,000,000 of investment income. The corporate tax rate on this investment income through an Ontario CCPC is 50.17% (in 2022).
If Jenny ran an active business through a corporation, the tax rate would’ve been 26.5%.
Note that the rules for taxing investment income at high rates generally only apply to CCPCs. So, if Jenny can find a way to make her corporation a non-CCPC, she may avoid the high tax.
Under the current rules, there are ways to make it so that the investment income is taxed at 26.5% instead of 50.17%. This often involves one of the following strategies:
- continuing the corporation out of Canada and into a tax haven
- issuing “Skinny” voting shares
- issuing option to acquire control to a non-resident person
All these strategies have the effect of turning a CCPC into a Non-CCPC so that all of its income, including investment income, gets taxed at 26.5%. This way, Jenny can pay a low initial tax on investment income and grow her wealth.
These transactions don’t appear to be “illegal” and often can be accomplished by the letter of the law (whether they fall under the “General Anti Avoidance Rule” is something that has yet to be tested in the courts).
For this reason, the government is proposing to make the following transactions as “notifiable transactions.”
Foreign continuance
A taxpayer’s corporation that holds investment assets and that is initially incorporated in Canada, is later continued under the laws of a foreign jurisdiction. As a result, it ceases to be a CCPC because it is no longer a “Canadian corporation.” However, by ensuring that the central management and control of the corporation are exercised in Canada, the corporation remains resident in Canada and, as a result, it is not considered to have emigrated. It is not subject to the foreign accrual property income regime.
“Skinny” voting shares
On or after incorporation, a corporation that holds, issues a majority of special voting shares, redeemable for a nominal amount (also known as “skinny” voting shares), to a non-resident person to cause the corporation not to be “Canadian-controlled” and, as such, to not be a CCPC. The non-resident person who owns the voting shares is often (but not necessarily) an entity owned and controlled by Canadian residents. Alternatively, the skinny voting shares could be issued to a public corporation instead of a non-resident person.
Option to acquire control
A corporation that holds investment assets, or assets that subsequently become investment assets, issues an option to a non-resident person to acquire a majority of the voting shares of a corporation to cause the corporation not to be “Canadian-controlled” and, as such, to not be a CCPC. This right to acquire control through the majority of the voting shares is often (but not necessarily) held by a non-resident entity that is owned by Canadian residents or accommodating non-resident persons. Alternatively, the option to acquire control could be issued to a public corporation instead of a non-resident person
Avoidance of deemed disposal of trust property
The Income Tax Act sets out what is generally referred to as the “21-year deemed realization rule” for a trust. The 21-year deemed realization rule generally treats capital property of a trust as having been disposed of and reacquired by the trust every 21 years at the property’s fair market value. The purpose of this rule is to prevent the use of trusts to defer taxes on capital gains indefinitely.
Taxpayers can avoid the 21-year deemed realization by having the trust transfer trust property to capital beneficiaries on a tax-deferred basis before the 21-year deemed realization date. A deferral of the 21-year deemed realization rule is generally not possible when the property is transferred from a trust (the “transferor trust”) to another trust (the “receiving trust”).
In addition, distributions of a trust’s property to non-resident beneficiaries will be subject to the application of subsections 107(5) and (2.1). In these circumstances, a rollover is not available, and the distributed property will be deemed to be disposed of at fair market value.
The Department of Finance is stating that some taxpayers are engaging in transactions that seek to avoid the 21-year deemed realization rule or that seek to avoid the rules preventing rollovers to non-resident beneficiaries.
For this reason, the government is proposing to make the following transactions as “notifiable transactions.”
Indirect transfer of trust property to another trust
A Canadian resident trust (“New Trust”) holds shares of a corporation resident in Canada (“Holdco”) that is or will become a beneficiary of another Canadian resident trust (“Old Trust”) that holds property that is capital property. At any time before its 21st anniversary, Old Trust transfers the property to Holdco on a tax-deferred basis.
As a result, the 21-year rule will not apply to Old Trust. A new 21-year period will start to run with respect to New Trust, providing for a much more extended deferral period. New Trust’s assets will reflect the property formerly held by Old Trust but may have a higher tax basis than such property.
Indirect transfer of trust property to a non-resident:
One or more non-resident beneficiaries of a Canadian resident trust hold shares of a corporation resident in Canada (“Holdco”) that is or will become a beneficiary of the trust. At any time before its 21st anniversary, the trust transfers property to Holdco on a tax-deferred basis.
The 21-year rule will not apply to the trust, with the transfer of the trust’s property to Holdco providing for a much longer period of deferral. The non-resident beneficiaries of the trust hold shares of Holdco that reflect their former indirect interest in the property of the trust.
Transfer of trust value using a dividend
A Canadian resident trust (“New Trust”) holds shares of a corporation (“Holdco”) that is or will become a beneficiary of another Canadian resident trust (“Old Trust”) that holds property that is shares in a Canadian corporation (“Opco”).
At any time prior to Old Trust’s 21-year anniversary, Opco redeems shares held by Old Trust and issues a promissory note or gives cash as consideration. In so doing, Opco is deemed pursuant to subsection 84(3) to have paid, and Old Trust is deemed to have received, a dividend equal to the amount by which the amount paid by Opco on the redemption exceeds the PUC in respect of the shares. The deemed dividend is designated by Old Trust and deemed to be received by Holdco pursuant to subsection 104(19). The dividend is deductible in the hands of Holdco pursuant to subsection 112(1). The cash or the promissory note is paid or made payable in the year by Old Trust to Holdco as payment for the dividend allocated to it.
In the result, the 21-year rule will not apply to Old Trust, and a new 21-year period will start to run for New Trust, providing for a much longer period of deferral. New Trust’s assets will reflect the value of the property formerly held by Old Trust but will undoubtedly have a significantly higher tax basis than such property.
Notifying the CRA
A taxpayer who enters into a notifiable transaction, or a transaction that is substantially similar to a notifiable transaction – or another person who enters into such a transaction in order to procure a tax benefit for the taxpayer – would be required to report the transaction in prescribed form to the CRA within 45 days of the earlier of:
- the day the taxpayer (or a person who entered into the transaction for the benefit of the taxpayer) becomes contractually obligated to enter into the transaction; and
- the day the taxpayer (or a person who entered into the transaction for the benefit of the taxpayer) enters into the transaction.
A promoter or advisor who offers a scheme that, if implemented, would be a notifiable transaction, or a transaction that is substantially similar to a notifiable transaction would be required to report within the same time limits. In addition, it is proposed that an exception to the reporting requirement be available for advisors to the extent that solicitor-client privilege applies.
These proposed amendments are intended to provide information to the CRA and would not change the tax treatment of a transaction.
It is expected that every information return required to be filed in respect of a notifiable transaction must:
- describe the expected, claimed or purported tax treatment and all potential benefits expected to result from the transaction;
- describe any contractual protection with respect to the transaction;
- describe any contingent fees with respect to the transaction;
- identify and describe the transaction in sufficient detail for the Minister to be able to understand the tax structure of the transaction;
- identify the provisions – relied upon for the tax treatment – of any one or more of
- identify, to the best knowledge of the person who is filing the return, every person required under subsection 237.4(4) of the Act to file an information return in respect of the transaction; and provide such other information as is required by the information return.
Failure to Notify CRA?
If a taxpayer fails to notify the CRA of a notifiable transaction, we highlight the implications an penalties.
Reassessment Period
Where a taxpayer has a mandatory disclosure reporting requirement in respect of a transaction relevant to the taxpayer’s income tax return for a taxation year, the proposals provide that the normal reassessment period would not commence in respect of the transaction until the taxpayer has complied with the reporting requirement. As a result, if a taxpayer does not comply with a mandatory disclosure reporting requirement for a taxation year in respect of a transaction, a reassessment of the year in respect of the transaction would not become statute-barred.
Taxpayer Penalty
With respect to persons who enter into reportable or notifiable transactions, or for whom a tax benefit results from a reportable or notifiable transaction, these proposals include a penalty of
- $500 per week for each failure to report a reportable transaction or a notifiable transaction, up to the greater of $25,000 and 25 per cent of the tax benefit; or
- for corporations that have assets that have a total carrying value of $50 million or more, $2,000 per week, up to the greater of $100,000 and 25 per cent of the tax benefit.
Promoter Penalty
With respect to advisors and promoters of reportable or notifiable transactions, as well as with respect to persons who do not deal at arm’s length with them and who are entitled to a fee with respect to the transactions, a penalty would be imposed for each failure to report equal to the total of:
- 100 per cent of the fees charged by that person to a person for whom a tax benefit results;
- $10,000; and
- $1,000 for each day during which the failure to report continues, up to a maximum of $100,000.
These proposals are not yet law. Canadians are invited to provide comments on these draft proposals and the sample notifiable transactions here until April 5, 2022.
