The Federal Budget 2023 introduced several amendments to strengthen and modernize the General Anti-Avoidance Rule (“GAAR”). Some of the more notable amendments include the changes to the definition of “Avoidance Transaction” as well as the introduction of the concept of “Economic Substance”.
Avoidance Transaction – This test has been significantly broadened by replacing the “primary purpose” test with a “one of the main purposes” test. The taxpayer has the burden to prove that a transaction, either on its own or part of a series, was not undertaken with “one of the main purposes” being to generate a tax benefit. The effect of this change is that many more transactions will be considered to be an “avoidance transaction” for purposes of applying the GAAR.
Economic Substance – An economic substance test has been added to the GAAR in determining whether a transaction is a “misuse or abuse”. An “avoidance transaction” that is “significantly lacking in economic substance” is presumed (although rebuttable in some circumstances) to indicate an abusive tax avoidance transaction.
A penalty equal to 25% of the amount of the tax benefit will be applied (unless the taxpayer has relied on existing case law or CRA positions at the time the transaction is entered into) to transactions that are subject to the GAAR unless the transaction is disclosed to the CRA. Disclosure can be made under the mandatory disclosure rules (for reportable transactions or notifiable transactions) or can be disclosed voluntarily. If the transaction is not disclosed, the normal reassessment period is extended by a further 3 years.
How Are Capital Gains Strips Affected?
Unfortunately, the era of capital gains planning seems to be coming to an end. In the Department of Finance (“Finance”) release dated August 4, 2023, there is specific reference to certain types of transactions that Finance views as “significantly lacking in economic substance”. As you may have guessed by now, capital gains strips are specifically referenced by Finance as an example of a transaction that is “significantly lacking in economic substance” and therefore GAAR is likely to be applied to these types of transactions.
Revisions to the GAAR are effective for transactions that are entered into as of January 1, 2024 and beyond. Taxpayers considering capital gains planning (often referred to as a “strip”) should do so before the end of 2023.