What You Need to Know About GAAR and How to Fight it

Introduction

Most businesses and individuals in Canada want to pay as little tax as necessary. The Income Tax Act (the “ITA”) does not prohibit individuals or businesses from engaging in tax planning. Corporate rollovers, corporate re-organizations, the use of trusts, intercorporate dividends, and other transactions that may result in reduced tax obligations are legitimate forms for individuals and businesses to manage their affairs.

Despite their legality, the Canada Revenue Agency (CRA) often tries to disallow such tax-planning transactions on the grounds that they violate the General Anti-Avoidance Rule (“GAAR”) under s.245 of the ITA. The financial impact of a GAAR assessment on the taxpayer can be dire. Fortunately, despite CRA’s persistence, taxpayers can successfully defend themselves against GAAR, particularly when they partner with an experienced tax dispute resolution team.  

What is GAAR

Enacted in the late 1980s, GAAR is meant to prevent taxpayers from undertaking “abusive” transactions whose primary purpose is tax avoidance. The CRA typically threatens to impose GAAR on transactions that it considers counter to the spirit of the ITA. If GAAR is found to apply, the taxpayer will lose any tax benefit obtained through the supposedly abusive transaction. The taxpayer may also lose valuable opportunity costs, as it can take years before a transaction is ruled to be in violation of GAAR, not to mention the various expenses spent on undertaking the original transaction in the first place. Taxpayers in Quebec also face additional GAAR-based penalties of 25% - 50% of the denied tax benefit. Yet when approached properly, GAAR’s bark is much louder than its bite.

GAAR is hard to prove

In Canada Trustco v R [1], the Supreme Court of Canada stated that for GAAR to apply to a transaction, the Crown must prove the existence of the following: 

a)       a tax benefit,

b)      an avoidance transaction, and

c)       a misuse of provisions of the ITA or an “abuse” of the provisions of the ITA read as a whole.

These requirements make GAAR quite difficult to establish. First off, the burden is on the Crown to prove GAAR should apply. This makes GAAR disputes profoundly different from most other tax disputes. In normal disputes, the Crown simply makes an assumption about the taxpayer’s activities and the taxpayer then bears the burden of “demolishing” the Crown’s assumption. In other words, in ordinary tax disputes, the taxpayer is guilty unless she proves otherwise. But under GAAR, the taxpayer is innocent unless the Crown proves otherwise. 

Second, the term “abuse”—the key element of GAAR—is notoriously vague. The case law is littered with inconsistent decisions, such that nearly identical transactions are found to be “abusive” in one case and not in another. As such, the Crown cannot rely on a clear definition of “abuse,” making it difficult to mount a successful GAAR case against taxpayers. Moreover, where the existence of an abuse is unclear, the benefit of the doubt goes to the taxpayer. Not surprisingly, since GAAR was enacted in the mid 1980s, the Minister of National Revenue has only brought around 50 GAAR cases to trial and has won only approximately half of them.[2]

How to beat GAAR

The most effective way to fight GAAR is to show that the taxpayer undertook the challenged transaction in good faith and with a primary purpose that is not tax avoidance. The primary purpose of a transaction may, for example, include corporate reorganization, asset protection, or succession planning, to name just a few.

When assessing taxpayers with GAAR, the CRA doesn’t always fully consider the context and facts surrounding the transactions that lead to tax benefits. However, these factual circumstances are often decisive in a GAAR case. The courts place significant weight on the context in which the transaction occurred when determining if the transaction was abusive. Thus, taxpayers are well positioned to successfully defend themselves against GAAR if they can present factual evidence to prove that the main purpose for entering into a transaction was not tax avoidance.

If you received a GAAR assessment, or if you are considering a transaction that you fear may one day trigger a GAAR assessment, contact Dean Blachford at Blachford Tax Law to discuss your options. Blachford Tax Law has extensive experience working with taxpayers and their accountants to successfully manage CRA audits and dispute CRA assessments.

Disclaimer

This article is for informational purposes only and does not constitute legal advice. If you wish to discuss your issue with a lawyer, contact us today at (613) 702-0322 or info@blachfordtaxlaw.com

[1] 2005 SCC 54.

[2] 2014 Spring Report of the Auditor General of Canada at Chapter 3 – Aggressive Tax Planning.