Budget 2023: Raising The Stakes For Aggressive Tax Planning

• Jurisdiction: Canada
• Law Firm: Aird & Berlis LLP
• Subject Matter: Finance and Banking, Tax, Financial Services, Income Tax, Capital Gains Tax, Tax Authorities
• Author: Aird & Berlis Tax Group
• Published date: 30 March 2023

INTRODUCTION

The 2023 Canadian Federal Budget ("Budget 2023") was released on March 28, 2023 ("Budget Day"), by the Department of Finance ("Finance"). As in prior years, Budget 2023 establishes some of Finance's most significant tax measures and contains various proposals to amend the Income Tax Act (Canada) ("ITA") and the Excise Tax Act (Canada) ("ETA").

In contrast with what is now almost routine speculation, Budget 2023 does not contain any proposal to increase the capital gains inclusion rate. It does, however, contain significant proposed amendments in the business income tax context, including the following:

• significant changes to the general anti-avoidance rule ("GAAR") to address some of Finance's major concerns with the GAAR, including the introduction of a 25% penalty, which may have a chilling effect on tax planning;
• beginning in 2024, there will be a 2% tax levied on repurchases of equity by most publicly-listed Canadian corporations, trusts and partnerships;
• the elimination of the dividend received deduction for dividends received by financial institutions on shares that are mark-to-market properties; and
• a number of tax credits for green energy and manufacturing.

On the personal tax front, Finance proposes to increase the Alternative Minimum Tax ("AMT") from 15% to 20.5% and to make various amendments that would broaden the tax base for the AMT. By exempting low-to-middle income earners, these measures are intended to target "high" income earners.

In order to address certain intergenerational transfers of businesses, Budget 2023 also contains proposed legislation to amend the rules introduced in Bill C-208 to ensure that they apply only to transactions involving genuine intergenerational business transfers.

Finance has not introduced any proposed amendments to the ITA in the international tax context in Budget 2023, but has provided an update on developments in international tax reforms and Canada's status on implementing the objectives outlined in Pillar One and Pillar Two of the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting.

BUSINESS INCOME TAX MEASURES

1. Modifications to the GAAR

In August 2022, Finance released a consultation paper discussing potential amendments to the GAAR to address perceived shortcomings in its scope. Budget 2023 proposes to:

1. introduce a preamble that establishes a statutory interpretative guide for the GAAR;
2. lower the threshold test in the definition of "avoidance transaction" from a "primary purpose" test to a "one of the main purposes" test;
3. expressly introduce the concept of economic substance in the "misuse or abuse" analysis;
4. impose a 25% penalty on the amount of any tax benefit assessed under the GAAR; and
5. extend the period within which the Canada Revenue Agency ("CRA") may assess or reassess under the GAAR by three years under certain circumstances.

Preamble

Finance believes that adding a preamble to the GAAR in new subsection 245(0.1) of the ITA will help address interpretive issues and ensure that the GAAR applies as Finance intended. The proposed preamble provides that the GAAR:

1. applies to deny the tax benefit of avoidance transactions that result directly or indirectly either in a misuse or abuse of a provision of the ITA or any other listed enactments, while allowing taxpayers to obtain tax benefits contemplated by the relevant provisions;
2. strikes a balance between a taxpayer's need for certainty in planning their affairs and the Government of Canada's responsibility to protect the tax base and the "fairness" of the tax system; and
3. can apply regardless of whether a tax strategy is foreseen.

Avoidance Transaction

The GAAR applies only if there is an avoidance transaction, which is currently defined to refer to transactions that are primarily undertaken to obtain a tax benefit. Budget 2023 proposes to reduce this threshold test from a "primary purpose" test to a "one of the main purposes" test. Amending the GAAR in this manner could materially broaden its scope. However, Finance believes this proposed change strikes a reasonable balance, positing that the proposed test would apply to transactions with a significant tax avoidance purpose, but not to transactions where tax was simply a consideration.

Finance did not propose other amendments to the definition of "avoidance transaction" to address certain concerns, such as whether the avoidance of foreign tax should be considered a bona fide non-tax purpose. According to Finance, the expanded definition would produce "appropriate results" in circumstances where such issues arise - although it is unclear how this would be the case.

Economic Substance

Finance also proposes to introduce an economic substance analysis in the misuse or abuse test. New subsection 245(4.1) provides that if an avoidance transaction is significantly lacking in economic substance, that tends to indicate that the transaction results in a misuse or an abuse. For these purposes, factors that tend to establish that a transaction or series of transactions is significantly lacking in economic substance include:

1. all or substantially all of the opportunity for gain or profit and risk of loss of the taxpayer - taken together with those of all non-arm's-length taxpayers - remains unchanged, including because of a circular flow of funds, offsetting financial positions, or the timing between steps in the series of transactions;
2. it is reasonable to conclude that, at the time the transaction was entered into, the expected value of the tax benefit exceeded the expected non-tax economic return (which excludes both the tax benefit and any tax advantages connected to another jurisdiction) and
3. it is reasonable to conclude that the entire, or almost entire purpose for undertaking or arranging the transaction or series was to obtain the tax benefit.

The introduction of a statutory economic substance concept in the GAAR may expand what constitutes a misuse or abuse and may encourage the CRA to reassess certain types of tax-motivated transactions that Finance finds abusive. Finance states, however, that a lack of economic substance will not always mean that a transaction is abusive and it would still be necessary to determine the object, spirit, and purpose of the provisions or scheme relied upon in line with existing GAAR jurisprudence.

Penalties and Extension of Reassessment Periods

Finance proposes to introduce a penalty for transactions subject to GAAR. The penalty would be 25% of the amount of the tax benefit. However, where the tax benefit involves a tax attribute that has not yet been used to reduce tax, the amount of the tax benefit would be considered to be nil for purposes of the penalty. The penalty, if otherwise applicable, could be avoided if the transaction is disclosed to the CRA, either as part of the proposed mandatory disclosure rules or voluntarily. Consequential amendments are proposed to the reportable transaction rules to permit voluntary reporting, which would effectively integrate GAAR with the mandatory disclosure rules.

Finally, a three-year extension to the normal reassessment period would be provided for GAAR assessments, unless the transaction had been disclosed to the CRA. This would effectively extend the limitation period to six, seven or 10 years, depending on the type of taxpayer and the transactions involved.

The proposed amendments, if enacted, may effectively compel taxpayers to self-report transactions that could be characterized as avoidance transactions in order to eliminate the risk of incurring the 25% penalty and the extended reassessment period.

Finance has invited public consultation on the proposed amendments to the GAAR until May 31, 2023, after which Finance will publish revised legislative proposals.

2. Tax on Repurchase of Equity

The 2022 Fall Economic Statement demonstrated Finance's intention to introduce a tax on share buybacks by public corporations, and Budget 2023 delivers on this promise by introducing a 2% tax on the net value of a listed entity's repurchase of equity. This tax applies to covered entities, which are generally Canadian-resident corporations (other than mutual fund corporations) whose shares are listed on a designated stock exchange, real estate investment trusts, specified...