General anti-avoidance rule (GAAR)
Overview
What is GAAR
The Canada Revenue Agency (CRA) is committed to protecting the integrity of Canada’s tax base and uses a multi-faceted approach to address tax avoidance. This approach relies on communication, compliance monitoring, responsible enforcement, a voluntary disclosure program and a strong policy and legislative base.
The CRA knows that most Canadians comply with their tax obligations. Canadian courts have held that, in general, taxpayers have the right to arrange their affairs in a way that will minimize their tax liability. However, that right has been restricted in Canada by targeted and specific statutory anti-avoidance rules as well as a General Anti-Avoidance Rule to address aggressive tax avoidance arrangements that compromise the integrity of the tax system.
Purpose of GAAR
The GAAR strikes a balance between protecting the tax base and taxpayers’ need for certainty in planning their affairs. Its purpose is to deny tax benefits to any taxpayer that, although complying with a literal reading of the provisions of the tax rules, are not in compliance with the object, spirit or purpose of the legislation. The GAAR can also apply to tax avoidance transactions undertaken primarily to secure a tax benefit afforded by a tax treaty.
What else you should know about GAAR
The CRA chairs an interdepartmental GAAR Committee that includes the Departments of Finance and Justice to ensure that the GAAR is applied consistently. Unless the Committee has previously reviewed a similar issue or transaction, the CRA consults the Committee before it relies on the GAAR (as a primary or alternative assessing position) to deny a tax benefit.
Taxpayers should be aware that the GAAR applies to an avoidance transaction. This is generally any transaction, or any transaction in a series of transactions, that results in a tax benefit, unless the taxpayer has made the transaction for a non-tax purpose (that is, the transaction is bona fide or genuine except for the tax benefit).
A tax benefit can include a reduction, an avoidance or a deferral of tax or other amount, or an increase in a refund of tax or another amount. A tax benefit can also include a reduction, increase or preservation of an amount that could at a subsequent time be used in calculating a taxpayer’s liability. When there is an avoidance transaction, the CRA may deny the tax benefit if the result of the transaction(s) defeats the object, spirit or purpose of the rules for income tax.
Examples of when the CRA would apply the GAAR
Generally, the CRA considers applying the GAAR whenever a taxpayer makes a transaction mainly to avoid, defer or reduce tax and that transaction results in an outcome that is inconsistent with the object, spirit and purpose of the relevant tax rules.
The following are some examples of tax avoidance schemes where, in the CRA’s view, the GAAR would apply.
This is not an exhaustive list of circumstances in which the CRA will apply the GAAR. Furthermore, all organization names and transactions are stylized examples. Any resemblance to actual organizations or actual transaction details is purely coincidental. The examples are not meant to limit in any way the position that the Crown would take with respect to the GAAR in new or ongoing cases.
Taxpayers, including in-house tax advisers and the audit committees of public companies, may want to consult these examples to determine whether any tax planning they are contemplating is similar.
The CRA will update this list from time to time to add other types of transactions.
If you are aware of examples of transactions to which the CRA should consider applying the GAAR, you are invited to send them to CPILBDISSUG@cra-arc.gc.ca.
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Surplus stripping
Targeted abuse
A transaction for the benefit of a shareholder who is an individual or a non resident taxpayer that results in the withdrawal or potential withdrawal of surplus (retained earnings) of a corporation in a manner that reduces the tax base and/or a return of capital in excess of the amount that reflects the investment made with after-tax funds.
Abusive arrangement
Transactions undertaken to strip corporate surplus in a manner that defeats the object, spirit and purpose of sections 84, 84.1, 212.1 and subsection 89(1) of the Income Tax Act are subject to the application of the GAAR.
Transactions – Scenario 1
- Individual holds high ACB Class B shares on which the capital gains exemption was previously crystallized
- Subco transfers Property A to Holdco in consideration for Class B shares of Holdco
- As a result, the PUC of the Class B shares is increased across all Class B shares
Before:
Image description
The before image shows the situation before entering the series of transactions. An individual holds common shares and Class B shares of Holdco. In turn, Holdco holds Class A shares of Subco. The common shares of Holdco have nominal value. The Class B shares of Holdco held by the individual have a fair market value (FMV) of $4,000,000, an ACB of $750,000 (because of a previously crystallized capital gain exemption) and PUC of $1. Subco holds property A with a FMV of $925,000.
After:
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The after image shows the result of the transaction in which Subco transferred Property A to Holdco in consideration for Class B shares of Holdco. This transaction resulted in an increase of the PUC of the Class B shares held by the individual up to $750,000 (rounded amount).
Transactions – Scenario 2
- Canco redeems the preferred shares held by the individual, triggering a deemed dividend of $849,999 and an equivalent capital loss which is added to the ACB of the common shares under subsection 40(3.6)
- Individual transfers their common shares to Holdco in consideration of preferred shares with an ACB and redemption value equivalent to the $850,000 and nominal value common shares
- Holdco redeems the preferred shares without any tax consequences
Before:
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The before image depicts the following: The individual holds common shares and preferred shares of Canco. The common shares have an FMV of $850,000 and a nominal ACB. The preferred shares are shares on which a capital gain exemption was crystallized. Hence, the PUC of the preferred shares was at $1 and the FMV and the ACB were at $850,000. Circle number 1 shows the preferred shares being redeemed. The green rectangle on the left shows that the capital loss is added to the ACB of the common shares held by the individual. Circle number 2 illustrates the transfer of the common shares to Holdco.
After:
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The after image is the result of the transfer of the common shares to Holdco. The individual now holds common shares and preferred shares of Holdco. The common shares have a nominal ACB and FMV. The preferred shares have an FMV, PUC and ACB of $850,000. Holdco holds common shares in Canco. Circle number 3 shows the preferred shares held by the individual in Holdco being redeemed.
Transactions – Scenario 3
- By a series of transactions, Canco and Subco, two Canadian corporations within the same corporate group that had been parent and subsidiary became "sister" corporations
- Subsequently, Canco and Subco proceeded with a horizontal amalgamation
Before:
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The before image depicts the following: Parent, a foreign corporation, holds shares of Forco. Parent holds common shares of Canco that have an FMV of $200 million, and an ACB and a PUC of $100 million. Canco holds common shares of Subco that have an FMV of $2 million, and an ACB and PUC of $40 million. Circle number 1 shows Canco selling its common shares of Subco to Forco at FMV.
After:
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The after image illustrates the result of the sale. Parent holds common shares of Canco. And Parent holds shares of Forco, which in turn holds common shares of Subco. Circle number 2 shows the horizontal amalgamation of Canco and Subco. The plus sign emphasizes that the tax attributes of the shares of the merged corporation are the sum of the tax attributes of the common shares of the merging corporations, resulting in a PUC of $140 million.
Creation of an artificial capital loss
Targeted abuse
Targeted abuse is the offsetting of a capital gain with an artificial capital loss (a loss that does not reflect a true decline in value of a capital asset or where there was no change in the taxpayer's overall economic power), which results in a misuse and abuse of sections 38, 39 and 40 of the Income Tax Act when read as a whole.
Abusive arrangement
Transactions referred to as value shifts are where losses are created through a series of transactions designed to shift value from an existing class of shares to a newly issued class of shares. The initial shares are then sold to a non-affiliated person resulting in an artificial capital loss that is used to offset a pre-existing or future capital gain.
Transactions
- Individual subscribes for common shares of Canco
- Canco declares a dividend on the common shares held by the individual. The dividend is payable by the issuance of preferred shares with high redemption value and low paid-up capital (commonly known as high/low shares)
- Individual sells its common shares of Canco to a non-affiliated person for a nominal amount. The disposition results in a capital loss
Before:
Image description
The before image depicts the following: Circle number 1 shows an individual subscribing to common shares of Canco. The common shares have a high FMV and a high ACB. Circle number 2 shows that a high FMV/low PUC stock dividend is declared on the common shares of Canco.
After:
Image description
The after image depicts the following: Circle number 3 shows the sale by the individual of the common shares (that now have a low FMV and a high ACB) for a nominal amount to a non-affiliated person. This triggers a capital loss. Finally, the image shows the individual still holding preferred shares of Canco resulting from the stock dividend that have a high FMV and a low PUC.
Discretionary trusts and the application of the 21-year deemed disposition rule
Targeted abuse
The purpose of subsection 104(4) of the Income Tax Act is to prevent the use of trusts to defer indefinitely the recognition for tax purposes of gains accruing on certain types of property, mainly capital property. Subsection 104(4) generally treats capital property of a trust (other than certain trusts for the benefit of the settlor, for a spouse or common-law partner of the settlor, or for their joint benefit) as having been disposed of and reacquired by the trust every 21 years at the property's fair market value.
Moreover, subsection 104(5.8) of the Income Tax Act is an anti-avoidance rule designed to prevent the avoidance of the 21-year rule through the use of trust-to-trust transfers that do not involve dispositions of property at fair market value.
As stated during the 2017 CTF Annual Conference, the CRA will consider the application of the GAAR where transactions result in the "avoidance of the 21-year rule by trusts."
Abusive arrangement
This planning involves a transaction(s) or arrangement designed to avoid, or resulting in the avoidance of the 21-year rule by trusts, whether these are situations involving the distribution of property from a family trust to a Canadian corporation with non-resident shareholders, or the distribution of property by a Canadian resident discretionary family trust to a Canadian corporation whose shares are owned by another Canadian resident discretionary family trust [circumventing the application of subsection 104(5.8)].
Transactions – Scenario 1
- Old Trust is approaching its 21st anniversary
- Canco is wholly owned by a newly established discretionary trust resident in Canada (New Trust)
- Canco is or will become a beneficiary of Old Trust pursuant to its trust indenture
- Old trust distributes its property with an unrealized gain to a Canco on a tax-deferred basis
Before:
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The before image depicts a trust approaching its 21-year anniversary (Old Trust) that has property with a high FMV and a low ACB.
After:
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The after image shows blue arrows depicting the distribution by Old Trust, on a tax-deferred basis, of its property to Canco, one of its beneficiaries. Canco is owned by a newly established discretionary trust (New Trust) whose beneficiaries are the same as Old Trust. The brown X shows that Old Trust ceases to exist.
Transactions – Scenario 2
- Old Trust is approaching its 21st anniversary
- Canco is wholly owned by the non-resident beneficiaries of Old Trust
- Canco is or will become a beneficiary of Old Trust pursuant to its trust indenture
- The property held by Old Trust is distributed on a tax-deferred basis to Canco
Before:
Image description
The before image shows the following: Old Trust has non-resident beneficiaries and property with a high FMV and a low ACB. A footnote says that the property is not a property described in subparagraph 128.1(4)(v)(i) to (iii) of the Income Tax Act.
After:
Image description
In the after image, blue arrows show that property of Old Trust is distributed on a tax-deferred basis to Canco, a corporation held by non-resident beneficiaries of Old Trust. The brown X shows that Old Trust ceases to exist.
Misrepresentation and Penalties
Pursuant to subparagraph 152(4)(a)(i), the CRA may reassess a particular tax return beyond the normal reassessment period in circumstances of misrepresentation "attributable to neglect, carelessness or willful default," or where there is fraud. For a penalty to apply under subsection 163(2), a taxpayer must have knowingly, or under circumstances amounting to gross negligence, made a false statement or an omission in their return.
The scope for their application is not limited to particular provisions of the Act but applies for the purpose of the Act as a whole, including section 245 of the Act. Therefore, the CRA could consider the application of either of the provisions above to tax avoidance arrangements involving the application of the GAAR.
Whether the subsection 163(2) penalty applies in a given case, or whether there has been a misrepresentation or fraud in accordance with subparagraph 152(4)(a)(i), is a question of fact that can be determined only after a review of all the facts and circumstances. For example, a penalty may be considered in a situation where the taxpayer has disregarded the jurisprudence confirming the application of the GAAR in circumstances similar to the transaction(s) undertaken by or with the taxpayer.
GAAR Penalty
Since June 2024, the legislation includes under subsection 245(5.1) a penalty applicable to the amount of tax payable and to refundable tax credits reduced as a result of the application of the GAAR. The penalty applies to a transaction only if the transaction or the series that includes the transaction was not disclosed to the Minister of National Revenue. The amount of the penalty will be reduced by any gross negligence penalty calculated under subsection 163(2) with respect to the same transaction or series where the GAAR penalty applies.
An exception to the penalty is available under subsection 245(5.2). Subsection 245(5.2) is intended to be a narrow rule that may apply in circumstances where a taxpayer entered into a transaction reasonably relying upon the current state of the case law and administrative guidance from the Minister of National Revenue.
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