Tax Insights: Canada Revenue Agency officially designates first notifiable transactions

November 08, 2023

Issue 2023-33

In brief

On November 1, 2023, the Canada Revenue Agency (CRA) designated its first set¹ of transactions for the purposes of the recently enacted “notifiable transactions” regime, which forms part of Canada’s enhanced mandatory disclosure rules (MDR). The transactions and their related descriptions are identical to the sample designated transactions that were released on February 4, 2022, except that they:

are now stated to be effective November 1, 2023, and
no longer include the manipulation of Canadian-controlled private corporation status

In addition, on November 2, 2023, the CRA issued updated guidance on various aspects of the MDR regime, including some important statements on the transitional application of the rules for notifiable transactions. Together, these documents imply that the first filings for notifiable transactions will be due no earlier than January 30, 2024.

The enhanced MDR regime, enacted on June 22, 2023, is comprised of three distinct elements:

reportable transactions, triggered by a tax avoidance purpose and the presence of one of three generic hallmarks
uncertain tax treatments, triggered by financial statement recognition of tax uncertainties
notifiable transactions, triggered by resemblance to specifically designated transactions

This Tax Insights discusses the designated transactions and some of the guidance provided by the CRA relating to the notifiable transactions regime. For more information on all three elements of the MDR regime, see our Tax Insights “Mandatory disclosure rules: Taxpayers, advisers and promoters need to prepare.”

In detail

Background

Taxpayers, advisers and promoters are required to file a prescribed information return to report a transaction or series of transactions that is the same as, or substantially similar to, a designated transaction or series of transactions. Transactions will be considered substantially similar if they are expected to obtain the same or similar types of tax consequences and are either factually similar or based on the same or a similar tax strategy. The legislation specifies that this is to be interpreted broadly, in favour of disclosure.

Effective November 1, 2023, there are now designated transactions relating to the following:

straddle loss creation transactions using a partnership
avoidance of deemed disposal of trust property
manipulation of bankruptcy status to reduce a forgiven amount in respect of a commercial obligation
reliance on purpose tests in section 256.1 of the Income Tax Act to avoid a deemed acquisition of control
back-to-back arrangements

Designated transactions include both transactions that the CRA has found to be abusive and those identified as transactions of interest. Of the newly designated transactions, only the one relating to back‑to‑back arrangements seems to fall into the latter category. Designations can be for a single transaction or a series of transactions. If they are for a series, then each transaction in the series could be a “notifiable transaction” that is subject to reporting. However, there is a rule that allows a taxpayer to file one information return to report all transactions in the series, rather than filing multiple returns.

1. Straddle loss creation transactions using a partnership

This designation targets planning that uses offsetting gain and loss legs of financial instrument positions that are realized at slightly different times, allowing losses to be claimed while deferring the offsetting gain, potentially in perpetuity. The 2017 federal budget introduced specific anti-avoidance rules that targeted a type of these transactions where a loss leg was realized immediately before a tax year end and the gain leg was realized at the beginning of the following year. However, the federal government has identified a variant of this planning that uses partnerships, which is not subject to these anti-avoidance rules.

Designated transactions

This designation is for a series of transactions in which a partnership realizes a gain on a foreign exchange forward contract immediately before a taxpayer acquires an interest in the partnership, where the gain is allocated to a former partner and the offsetting loss leg is realized and allocated to the taxpayer.

2. Avoidance of deemed disposal of trust property

These designations target planning that is aimed at avoiding a deemed fair market value (FMV) disposition of property held by a Canadian-resident trust under the “21‑year rule.” The general intent of the 21‑year rule is to cause a disposition of trust property once every generation to prevent the indefinite deferral of gains.

The tax rules generally allow for a tax-deferred distribution of property by a trust to its beneficiaries, except that distributions:

to non-residents are immediately subject to a FMV disposition, and
to another trust will make that other trust subject to the 21‑year rule on the same basis as the first trust

The federal government is concerned that taxpayers are working around these rules.

Designated transactions

Three different transactions (or series) are designated.

The first designated transaction uses a technique where non-resident beneficiaries are able to avoid:

the 21‑year rule, and
the rule preventing the tax‑free rollout of property to non‑residents

Essentially, trust property is rolled out to a Canadian‑resident corporation that the non‑resident owns.

The second and third designated transactions are similar in substance, but:

the second transaction involves a full rollout of the underlying property of the “old” trust to a corporate beneficiary
the third transaction involves a partial distribution by way of a redemption of shares held by the trust, with the resulting deemed dividend being allocated to a corporate beneficiary

They both involve a “new” trust holding shares of a corporation that is, or will be, a beneficiary of the old trust.

3. Manipulation of bankruptcy status to reduce a forgiven amount in respect of a commercial obligation

This designation targets planning that uses bankruptcy to avoid the debt forgiveness rules. When a debtor has a debt forgiven, the “forgiven amount” is generally applied to reduce the debtor’s tax attributes (such as loss carryforwards) and/or create an income inclusion for the debtor. However, the forgiven amount to be applied is nil if the debtor is bankrupt at the time the debt is settled. The federal government is concerned that taxpayers are deliberately being assigned into bankruptcy to avoid the tax consequences of a debt forgiveness, and then having the bankruptcy annulled after the debt is forgiven.

Designated transactions

This designation relates to a series of transactions in which:

a taxpayer is assigned into bankruptcy
while the taxpayer is in bankruptcy, a debt of the taxpayer is settled for less than its principal amount, and
the taxpayer then has the bankruptcy annulled

4. Reliance on purpose tests in section 256.1 of the Income Tax Act to avoid a deemed acquisition of control

These designations focus on certain rules that police the trading of losses (and other corporate tax attributes) among arm’s length persons. The anti-avoidance rules in section 256.1 of the Income Tax Act are aimed at taxpayers that try to avoid these rules by:

acquiring shares having 75% or more of the FMV of all shares of a corporation, but without acquiring voting control of the corporation (the “75% rule”)
taking steps to not be subject to a further anti-avoidance rule that polices avoidance of the 75% rule, or
having a loss corporation acquire control of a profitable corporation

These anti-avoidance rules are subject to purpose tests. The federal government is concerned that taxpayers are taking aggressive positions in the application of these tests.

Designated transactions

Three different transactions (or series) are designated:

A single transaction in which a corporation acquires 75% or more of the FMV of all shares of another corporation that has unused tax attributes, but does not acquire voting control of the other corporation, and the taxpayer takes the position that it is not reasonable to conclude that one of the main reasons control was not acquired was to avoid the loss trading rules.
A series of transactions in which a corporation acquires shares of another corporation with unused tax attributes and would have satisfied the 75% rule in respect of the other corporation, but for the fact that a third (non-arm’s length) corporation also acquires shares of the other corporation. Assuming there is no group control, the taxpayer takes the position that the 75% rule does not apply, because it is not reasonable to conclude that one of the reasons the third corporation acquired the shares was to cause the first corporation to not meet the 75% rule in respect of the other corporation.
A single transaction in which a corporation with unused tax attributes acquires control of another corporation that is profitable. The taxpayer takes the position that it is not reasonable to conclude that one of the main reasons for the acquisition of control was to avoid the loss trading rules, even though it may be one of the reasons.

5. Back-to-back arrangements

These designations target planning that avoids the back‑to‑back lending rules in the thin capitalization and non‑resident withholding tax regimes. The back‑to‑back rules generally apply to planning that indirectly provides funding from a related non-resident to a Canadian resident using intermediaries. These rules are generally thought of as the back-to-back “loan” rules, however, the withholding tax rules also contemplate rent and royalty back‑to‑back arrangements, as well as similar arrangements that substitute one type of payment for another.

Designated transactions

These designations seem to fall into the category of “transactions of interest.” Two transactions (or series) are designated.

The first designation is in respect of the thin capitalization rules and describes a situation in which a non‑resident enters into an arrangement with an arm’s length non‑resident to indirectly provide financing to a Canadian taxpayer. The taxpayer takes the position that the thin capitalization rules do not apply to the interest it pays under the arrangement.

The second designation is in respect of the Part XIII withholding tax rules and describes a similar financing arrangement, except that the other non‑resident does not have to be at arm’s length. It also requires that if the Canadian taxpayer had paid interest directly to the first non‑resident, that interest would have been subject to Part XIII withholding tax. The Canadian taxpayer takes the position that the interest is either:

not subject to any withholding tax
subject to a lower rate than would have applied if it had been paid to the first non‑resident

The designation also includes similar arrangements in respect of rents, royalties and payments of a similar nature, and arrangements that effect a substitution of character. This is because the scope of the back‑to‑back rules for withholding tax is broader than interest on debt obligations.

Timing issues

The MDR guidance issued by the CRA states that:

the effective date for the designation of a notifiable transaction is the date it is posted on the CRA’s website (i.e. November 1, 2023 for this first set of designated transactions)
the first filing deadline for a notifiable transaction will be 90 days after the effective date of the relevant designation

This means that no reporting should be due before January 30, 2024.

The guidance also states that, for a targeted series of transactions that straddles the date of designation, reporting will be triggered by the first transaction entered into after the date of designation. Thus, it appears that a series of transactions that is completed before November 1, 2023, regardless of when the series started, may not require reporting. However, the prescribed form (RC312) for reporting notifiable transactions (which also covers the reportable transactions regime) does not currently contemplate reporting each transaction in a series. It only requires reporting the type of designated transaction that applies.

The takeaway

With the CRA’s publication of its first set of designated transactions, the final element of Canada’s three-part MDR regime is now in place. Taxpayers, advisers and promoters may need to file information returns in respect of notifiable transactions as early as January 30, 2024. The CRA continues to regularly issue new guidance on all three elements of the MDR regime, so it is possible that additional relevant guidance could be issued before the January 2024 deadline. The CRA has an email alert service² that should help keep taxpayers and their advisers up to date.

^{1. Canada Revenue Agency “Notifiable transactions designated by the Minister of National Revenue” (November 1, 2023) at www.canada.ca/revenue-agency.

2. Canada Revenue Agency “Electronic mailing list - Notifiable transactions” at www.canada.ca/revenue-agency.}