What you need to know about tax avoidance

The Duke of Westminster principle that tax planning (the act of arranging one’s affairs to minimize one’s tax liability) is a legitimate part of Canadian tax law has been reaffirmed numerous times by the Supreme Court of Canada.

Though legitimate, this principle is now limited by new rules requiring that tax planning comply not only with the letter of the law but also with other considerations, such as its spirit and intent. We call these “anti-avoidance” rules.

This article will help you better understand tax avoidance and the General Anti-Avoidance Rule.

In this article, you’ll learn about:

• Tax avoidance
• The General Anti-Avoidance Rule (GAAR)
• Aggressive tax avoidance
• How De Grandpré Chait’s tax litigation lawyers can help and advise you

Aggressive tax avoidance

While tax planning is permitted, the same cannot be said for aggressive tax avoidance, the tax benefits of which can be denied under the General Anti-Avoidance Rule, nor for tax evasion, which can result in criminal or penal charges.[1]

This distinction has recently been underscored by the Supreme Court in Canada v. Alta Energy Luxembourg S.A.R.L., 2021 SCC 49:

[47] First and foremost, tax avoidance is not tax evasion, and there is no suggestion by either party that the transaction in this case was evasive. In addition, tax avoidance should not be conflated with abuse. Even if a transaction was designed for a tax avoidance purpose and not for a bona fide non-tax purpose, such as an economic or commercial purpose, it does not mean that it is necessarily abusive within the meaning of the GAAR (Canada Trustco, at paras. 36 and 57; see also Lipson, at para. 38).

Tax planning

Tax planning occurs when a person arranges their affairs to minimize their tax liability while complying with the letter, spirit and intent of the law.

Aggressive tax avoidance

Aggressive tax avoidance occurs when a person arranges their affairs to minimize their tax liability while complying with the letter but not the spirit or intent of the law. The General Anti-Avoidance Rule was created to address aggressive tax avoidance.

Tax evasion

Tax evasion occurs when a person arranges their affairs to minimize their tax liability without complying with the letter, spirit or intent of the law. Tax evaders can face criminal or penal charges.

The General Anti-Avoidance Rule (GAAR)

There are two types of anti-avoidance rules: those that are specifically provided for by law and the General Anti-Avoidance Rule that applies where there are no specific anti-avoidance provisions.

The GAAR was enacted in 1988 to limit the use of aggressive tax avoidance tactics and prevent taxpayers from paying less than their fair share. It is set out in section 245 of the Income Tax Act (ITA).

The Honourable Minister of Finance Michael H. Wilson’s Explanatory notes to legislation relating to Income Tax (June 1988) defined the purpose of the GAAR as follows:

New section 245 of the Act is a general anti-avoidance rule which is intended to prevent abusive tax avoidance transactions or arrangements but at the same time is not intended to interfere with legitimate commercial and family transactions.  Consequently, the new rule seeks to distinguish between legitimate tax planning and abusive tax avoidance and to establish a reasonable balance between the protection of the tax base and the need for certainty for taxpayers in planning their affairs.

Section 245 ITA provides that for the GAAR to apply, three criteria must be met:

1. there is a tax benefit arising from a transaction;
2. the transaction is an avoidance transaction;
3. the avoidance transaction is abusive.[2]

To determine whether a transaction is abusive, “the Court has set out a two‑step inquiry. Under the first step, the provisions relied on for the tax benefit are interpreted to determine their object, spirit, and purpose. Under the second step, a factual analysis determines whether the avoidance transaction at issue frustrates the object, spirit, and purpose of the provisions.”[3]

To combat tax evasion and avoidance, the Canada Revenue Agency (CRA) is constantly adjusting its audit methods and has become better at uncovering and targeting aggressive tax planning.[4]

The CRA is also in the midst of consultations to improve Canadian income tax mandatory disclosures rules.[5] These new rules could lead the CRA to audit more tax plans for tax avoidance.

The Agence du revenu du Québec (ARQ), meanwhile, has already implemented a Mandatory or Preventive Disclosure of Tax Planning (TP-1079.DI-V) form requiring taxpayers to disclose certain transactions, including those discussed in our article Mandatory Transaction Disclosure Regulation by Mtre Martin Delisle and Mtre Lisa-Marie Gauthier.

Aggressive tax avoidance to which anti-avoidance rules apply

Interprovincial Québec Year-End Shuffle (Q-YES)-type tax planning (See among others: Développements Iberville ltée c. Agence du revenu du Québec, 2016 QCCQ 4765)

[TRANSLATION] “Q-YES tax planning was made possible by the fact that companies could select different federal and provincial fiscal year-end dates in order to have different tax data in each jurisdiction and be able to apply the business allocation formula provided for by regulation.

[…]

Since being able to select a different provincial fiscal year-end date opened the door to avoidance transactions that violate tax policy, the government announced on December 20, 2006 that, as of that date, this option would be abolished.”

How De Grandpré Chait’s tax litigation lawyers can help and advise you

As we’ve seen, tax planning can comply with the letter but not the spirit of the law. Caution is paramount in an ever-changing environment where rules and policies are constantly being updated. De Grandpré Chait’s tax law team can advise you on mandatory disclosure rules and help you understand whether the GAAR applies to you. Our tax specialists will help you see clearer.

­>>      Contact our tax litigation team.

[1] 239 ITA
[2] Canada v. Alta Energy Luxembourg S.A.R.L., 2021 SCC 49
[3] Ibid.
[4] https://www.canada.ca/en/revenue-agency/corporate/about-canada-revenue-agency-cra/transparency-proactive-disclosure-canada-revenue-agency/disclosure-briefing-binders-parliamentary-appearances/standing-committee-finance-2021-06-22.html#toc2
[5] https://www.canada.ca/en/department-finance/programs/consultations/2021/income-tax-mandatory-disclosure-rules-consultation.html