Estate advisors looking at tax minimization and corporate restructuring of their clients’ affairs as part of their estate and wealth planning will now need to consider the new changes to the General Anti-Avoidance Rule (GAAR). Bill C-59 was introduced in Parliament on November 30th, 2023, and a section of the Bill amends section 245 of the Income Tax Act (the Act) and the GAAR provisions found in subsection 245 of the Act.
Tax and estate advisors should familiarize themselves with the application of these revised provisions as they broaden the application of the GAAR while lessening the Minister’s burden of proof. The newly introduced GAAR preamble sets the tone that GAAR will (a) apply to deny a tax benefit from an avoidance transaction (or series of transactions) that results in a misuse or abuse of some provisions of the Act and (b) find a balance between the Canadian government’s responsibility to protect the tax base and the fairness of the system and the taxpayer’s need for certainty.
Tax Benefit & Lacking Economic Substance
A tax benefit is broadly defined as “a reduction, avoidance or deferral of tax or other amount payable under the Act or an increase in a refund of tax or other amount under the Act.” The new amendments may cause GAAR to apply if one of the main purposes for entering into the transaction was to obtain, directly or indirectly, a tax benefit; this lessens the Minister’s burden of proof.
Essentially, if a tax benefit was one of the purposes and the transactions (or reorganization) significantly lack in economic substance, the Minister may automatically presume a misuse of the Act and may apply GAAR to deny the tax benefit (leaving the taxpayer with the burden of justifying the legitimacy of the transactions). The “new GAAR” aims to add an explicit economic substance test. The Department of Finance has provided some factors that would establish a lack of economic substance:
- No substantial change in the opportunity for gain an no risk of loss for the taxpayer and non-arm’s length persons,
- The expected value of the tax benefit exceeds the expected value of the non-tax economic return, and
- The entire, or almost entire, purpose for undertaking or arranging the transaction was to obtain a tax benefit.
The GAAR Penalty Is Not Cheap…
The new GAAR rules also introduce a penalty of 25% of the total value of both the additional tax payable and reduced tax credit if GAAR applies. A taxpayer who is found to have misused the Act and gained a tax benefit would be subject to the 25% penalty. Such penalty is significant enough to force taxpayers and advisors to consider the GAAR as part of their tax planning.
For Estate Advisors
One component of estate planning is obviously tax minimization on death. As a result, estate advisors assisting clients with their estate and wealth preservation plan should consider the new GAAR rules when developing an estate plan; since inevitably there will be a tax benefit involved.
In the early days of the “new GAAR” environment, it will be a challenge for advisors to navigate the clients’ best interests as they strive to comply with the new GAAR. Would a typical estate freeze be considered GAAR-able? Probably not, yet it is doubtful a tax advisor would confidently give such assurance to the client. Could corporately-held insurance that is part of some estate and wealth planning strategy make that strategy GAAR-able? Again, it is unclear, but I would suggest that how the insurance is used (and if it is leveraged), may determine whether the strategy would be reviewed by the Minister.
It’s important that advisor closely review these new GAAR rules, as it may need to be considered as part of some of their estate and wealth planning strategies.