Tax Insights: Finance releases draft legislative proposals ─ Mandatory disclosure rules

In brief

On February 4, 2022, the Department of Finance released draft legislative proposals (the proposals) to implement numerous 2021 federal budget and other measures. The proposals include the 2021 federal budget proposal to enhance Canada’s mandatory disclosure rules by:

• changing the Income Tax Act’s (ITA’s) existing reportable transaction rules

• introducing requirements to report “notifiable transactions” and for “specified corporations” to report “uncertain tax treatments”

• extending the reassessment period in certain circumstances

• introducing penalties for non-compliance that will apply to both taxpayers and promoters or advisers

A backgrounder containing a list of sample “notifiable transactions” was also released. These rules are proposed to apply to taxation years that begin, and transactions entered into, after 2021. The penalty provisions, however, would not apply to transactions that occur before royal assent of the enacting legislation.

This Tax Insights discusses the proposed enhanced mandatory disclosure rules. Interested parties are asked to provide comments to the Department of Finance on these rules and the list of sample notifiable transactions by April 5, 2022.  

In detail

Reportable transactions

Current rules in the ITA require the reporting of a transaction if it is considered an “avoidance transaction” as that term is defined for the purposes of the general anti‑avoidance rule and it meets at least two of three defined hallmarks (contingent fee arrangement, confidentiality protection or contractual protection). The reporting is required to be made on or before June 30th of the calendar year following the calendar year in which it first becomes a reportable transaction.  

The proposals would:

• require only one of the three hallmarks to be present for a transaction to be reportable 

• amend the “contractual protection” hallmark to exclude protection offered in the context of normal commercial transactions to a wide market (e.g. standard commercial tax risk insurance), so that these protections would not trigger a reporting requirement

• amend the definition of “avoidance transaction” for these purposes, so that a transaction can be considered an avoidance transaction if it can reasonably be concluded that one of the main purposes of entering into the transaction is to obtain a tax benefit

Reporting obligation

A taxpayer would be required to report detailed information regarding the transaction to the Canada Revenue Agency (CRA) within 45 days of the earlier of the day that the taxpayer (or another person who entered into the transaction for the benefit of the taxpayer):

• becomes contractually obligated to enter into the transaction, or

• enters into the transaction

Reporting of these schemes by a promoter or adviser, with the same time limits, will also be required. An exception may be available for advisers, to the extent that solicitor-client privilege applies. 

Penalties

Significant penalties for failure to report are proposed for both taxpayers and promoters or advisers.  

Notifiable transactions

The proposals introduce a requirement to report pertinent information on a new category of specific transactions (known as “notifiable transactions'') to the CRA on a timely basis. The Minister of National Revenue, with the concurrence of the Minister of Finance, would have the authority to designate a transaction or series of transactions. A notifiable transaction is 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 similar tax strategy.

Notifiable transactions would include both transactions that the CRA has found to be abusive and transactions identified as transactions of interest. The description of a notifiable transaction is expected to set out the fact patterns or outcomes in sufficient detail to enable taxpayers to comply with the disclosure rule. 

Sample notifiable transactions 

As part of the proposals, the Department of Finance released a backgrounder¹ that contains a list of sample transactions (or series of transactions) that have been designated as “notifiable transactions” by the Minister of National Revenue. The sample notifiable transactions are grouped as follows:

• manipulating Canadian-controlled private corporation status to avoid anti-deferral rules that apply to investment income

• creating loss straddle transactions using a partnership

• avoiding the 21-year deemed disposition of trust property

• manipulating bankruptcy status to reduce a forgiven amount relating to a commercial obligation

• relying on purpose tests in section 256.1 of the ITA (tax attribute trading restrictions) to avoid a deemed acquisition of control

• using back-to-back arrangements to circumvent the thin capitalization rules and Part XIII withholding tax

Reporting obligation

Each taxpayer (or person who enters into a transaction for the benefit of a taxpayer) for whom a tax benefit results (or is expected to result) from a notifiable transaction or series of transactions would be required to report the transaction (or series) in prescribed form to the CRA within 45 days of the earlier of the day that the taxpayer (or another person who entered into the transaction for the benefit of the taxpayer):

• becomes contractually obligated to enter into the transaction, or

• enters into the transaction

Reporting of these schemes by a promoter or adviser, with the same time limits, will also be required. An exception may be available for advisers, to the extent that solicitor-client privilege applies. 

This disclosure would not change the tax treatment of a transaction. The information return required to be filed for a notifiable transaction must, among other disclosures: 

• describe the expected tax treatment (including the relevant legislative provision(s) to be relied on) and benefits of the transaction, as well as any contractual protection and contingent fees related to the transaction

• identify and sufficiently describe the transaction so the CRA can understand its tax structure

• identify every person required to file an information return relating to the transaction 

Penalties

Significant penalties for failure to report are proposed for both taxpayers and promoters or advisers.  

Uncertain tax treatments

Currently, there is no requirement to disclose uncertain tax treatments. The proposals would require a corporate taxpayer meeting the following conditions to report particular uncertain tax treatments to the CRA:

• the corporation is required to file a Canadian income tax return, and has at least $50 million in assets at the end of the taxation year 

• the corporation, or a group of which the corporation is a member, has audited financial statements prepared in accordance with International Financial Reporting Standards or other country-specific generally accepted accounting principles relevant for corporations that are listed on a stock exchange outside Canada 

• there is an uncertain tax treatment related to the corporation’s Canadian income tax reflected in the audited financial statements

Reporting obligation

A corporation would be required to report information on uncertain tax treatments at the same time that the reporting corporation’s Canadian income tax return is due. It is expected that the corporation would be required, for each reportable uncertain tax treatment (and the transaction to which the tax treatment relates), to:

• describe the relevant facts and the tax treatment taken (including the relevant legislative provision(s) to be relied on)
• provide the quantum of taxes at issue and whether the uncertainty (differences in tax):
  • relates to a permanent or temporary difference in tax
  • involves a determination of the value of any property, or a computation of basis

Penalties

Penalties of $2,000 per week, up to a maximum of $100,000, are proposed for a failure to timely report each particular uncertain tax treatment. 

Reassessment period

To encourage taxpayers to comply with the new mandatory disclosure rules, the proposals provide that the normal reassessment period would not commence in respect of a transaction, including an uncertain tax treatment, until the taxpayer has complied with the applicable reporting requirement. As a result, if a taxpayer does not comply in respect of a transaction, a reassessment in respect of the transaction would not become statute-barred.

The takeaway

These proposals significantly expand the types of transactions that could be reportable to the CRA. It will place a heavy burden on taxpayers and promoters or advisers to comply with these new disclosure obligations if they are involved in transactions designated as “notifiable transactions” or considered to have an uncertain tax treatment.  Although it is intended that reporting will be required for transactions entered into after 2021 that are the same as, or substantially similar to, transactions that are subsequently designated as notifiable transactions, the deadline for reporting such transactions is unclear. Late-filing penalties will not apply to transactions in 2022 that are undertaken before the date of royal assent of the enacting legislation for these rules, but the commencement of the reassessment period for such transactions could still be deferred until reporting occurs. 

Quebec’s mandatory disclosure rules for aggressive tax planning also include a requirement to disclose “specified transactions.” The sample list of federal notifiable transactions partially overlaps with Quebec’s list of specified transactions (for more information, see our Tax Insights “Quebec mandatory disclosure requirements: Deadline for reporting “specified transactions” coming soon!”).

^{1. Department of Finance, “Income Tax Mandatory Disclosure Rules Consultation: Sample Notifiable Transactions” (February 4, 2022) at www.canada.ca/en/department-finance.html.}