The General Anti-Avoidance Rule (GAAR)
The General Anti-Avoidance Rule (GAAR) was introduced in 1988, yet it still remains unknown and unclear to a great number of Canadian taxpayers.
The GAAR was introduced in Section 245 of the Income Tax Act with intention of giving the Canada Revenue Agency (CRA) increased abilities to target and challenge possible cases of tax avoidance and/or abuses of the tax system. Until the GAAR was introduced, no previous anti-avoidance measures had been in place.
Up until 1995, though a circular was issued by the CRA outlining what the GAAR covered, no judicial pronouncements were made. Following this year the CRA became successful in finding several cases in which the GAAR did apply.
The GAAR, in essence, legislates this: where a transaction or a series of transactions achieves a reduction, avoidance or deferral of tax, and those transactions or series of transactions are not conducted for any primary purpose other than to obtain a tax benefit, the tax consequences of the such may be invalidated.
The following is a general framework provided by the Supreme Court of Canada. In order for the GAAR to apply, lower courts will need establish that the following three points are relevant to the case in question:
- A tax benefit must have arose from a transaction or series of transactions. As virtually any plan that involves a tax deduction results in a tax benefit, this is the requirement most businesses or sole proprietors are likely to meet.
- The transaction, or any transaction(s) that occurred in a series of such is found to be an avoidance transaction. This means that the primary purpose of the transaction(s) is found to have been enacted in order to obtain a tax benefit. As most tax plans tend to involve numerous transactions, it is not uncommon that at least one of these – though part of a sequence involving a valid undertaking – is an avoidance transaction.
- Abusive tax avoidance is observed. This means that the tax benefits obtained in a transaction or series of such is found to be inconsistent with the object, purpose or spirit of the tax rule(s) used by the taxpayer to generate the said tax benefit. This is likely the most difficult clause to prove applies.
Should a taxpayer be accused of being in violation of the GAAR, it will be their responsibility to prove that they are not. Likewise it is the government’s responsibility to prove that the GAAR does indeed apply to the case at hand.
Confusion and the GAAR
Unfortunately rulings made stating that the GAAR did or did not apply seem to conflict one another. For instance, in the case of Overs, in order to repay a shareholder loan payable to his corporation, Mr. Overs sold shares to his wife. She, in turn, took out a loan to pay for these shares and deducted the interest charged on the loan. Mr. Overs used the proceeds of the share sales to repay the shareholder loan. Had he taken out a loan to repay the shareholder loan himself, his loan interest would not have been tax deductible. Thus Mr. Over avoided taxation.
In the case of Lipson the taxpayer’s spouse purchased shares of the family company from the taxpayer using a demand loan. The taxpayer in turn used the funds to purchase a home (as oppose to paying off a shareholder loan). The couple then applied for permanent financing secured by the mortgage on the home to repay the spouse’s loan. In the Lipson case, however, the court ruled that the GAAR did apply.
Successful Tax Planning
In guarding against a possible scenario in which the GAAR might apply to you, it is integral that you conduct your tax planning with a reputable financial planner and/or third party administrator. Remain up to date on changes made to the ITA and on the latest GAAR rulings.