New mandatory tax reporting: Final legislation released

The federal government has released final legislation on expanded tax reporting requirements aimed at detecting and preventing inappropriate tax plans. Find out about the final proposals, improvements and concerns that are still outstanding.

July 27, 2023: The CRA released guidance on the application of the mandatory disclosure rules along with the following prescribed forms:

Finally, we have been providing feedback to the government on areas where further guidance is needed. Please see our July 21, 2023, news item for further details.

In the 2021 federal budget, the government wrote: “The lack of timely, comprehensive and relevant information on aggressive tax planning strategies is one of the main challenges faced by tax authorities worldwide.”

To fill this gap, that budget announced plans for a consultation on more detailed reporting requirements for some types of transactions. The 60-day consultation was opened with the release of draft legislation and a backgrounder on February 4, 2022. The Joint Committee on Taxation of the Canadian Bar Association (CBA) and CPA Canada (Joint Committee) participated in the initial consultation and discussed the issues in more depth with the Department of Finance Canada (Finance). When the revised draft legislation was released in August 2022, we brought additional issues to the attention of Finance.

On March 28, 2023, revised legislation was released in a Notice of Ways and Means Motion, which later received first reading as Bill C-47 (Budget Implementation Act, 2023, No. 1). In Bill C-47, there were several changes that took into account feedback from the Joint Committee as well as other stakeholder groups. Bill C-47 did not contain any significant changes to the proposed Uncertain Tax Treatment rules.

In this blog, we update our original May 30, 2022 blog to reflect the final proposed rules in Bill C-47, summarize some outstanding concerns that our members and others have identified, and highlight the changes made, which were mostly consistent with the Joint Committee’s feedback.

The legislative proposals are organized into three components that would:

  • expand the current rules for reportable transactions;
  • introduce a new requirement to report notifiable transactions; and
  • add a new requirement for specified corporations to report uncertain tax treatments (UTT)

Where a filing requirement arises under the proposed reportable and notifiable transaction rules in Bill C-47, reporting is generally required within 90 days (up from 45 days under the original proposals) after the person enters into, or becomes contractually obliged to enter into, the transaction. Under Bill C-47, the requirement to report reportable and notifiable transactions applies in respect of transactions entered into after the legislation receives Royal Assent. The reporting timeline for UTTs remains unchanged and will apply to taxation years beginning after 2022, with reporting due six months after year-end.

Penalties would apply for failing to comply with the new rules, but these penalties will not apply to reportable and notifiable transactions entered into before Bill C-47 receives Royal Assent. In addition, the Canada Revenue Agency’s (CRA’s) ability to assess the transaction would not become statute-barred as long as the underlying transaction remains unreported. The usual assessment time period would only start when the disclosure has been made.

Balancing the CRA’s needs against compliance burdens

The original budget announcement highlights the importance of striking the right balance when setting disclosure rules.

On one hand, if the rules are too narrow, then the CRA may not receive the information it needs to properly administer the tax system when it needs it. On the other hand, it’s important to avoid putting more burden on taxpayers than necessary. The rules on reportable and notifiable transactions require action within 90 days of entering into a transaction. The government, therefore, needs to clearly show that the CRA needs to receive that information quickly and separately to do their job. If the CRA could get the added information it needs on a regular tax return, the requirement to file an additional information return separately and within 90 days would impose an extra — and inappropriate — compliance burden.

Further, the proposals carry significant penalties, and it seems unfair to penalize a failure to file what may be routine tax information.

The Organisation for Economic Co-operation and Development has emphasized the need for balance as a key for setting tax reporting rules, along with clarity, effectiveness and flexibility.

Mandatory disclosure regimes should be clear and easy to understand, should balance additional compliance costs to taxpayers with the benefits obtained by the tax administration, should be effective in achieving their objectives, should accurately identify the schemes to be disclosed, should be flexible and dynamic enough to allow the tax administration to adjust the system to respond to new risks (or carve-out obsolete risks), and should ensure that information collected is used effectively.

These principles are also at the heart of submissions to Finance, as well as various discussions on reportable transactions and notifiable transactions involving the Joint Committee.

When discussing the avoidance transaction definition, Finance made the following statement in the explanatory notes to the latest Notice of Ways and Means Motion:

Normal commercial transactions that do not pose an increased risk of abuse, in and of themselves, are not intended to result in a reporting obligation under these rules. It is expected that, over time, administrative guidance will be provided by the Canada Revenue Agency to assist taxpayers and tax professionals with the application of these rules.

Although this statement is welcome, there may be issues that cannot be dealt with on an administrative basis. Through the Joint Committee and other channels, we plan to discuss issues of concern with the CRA and will also communicate with Finance as needed.

Below we summarize some of the key issues that need to be considered under these rules.

Reportable transactions: current rules

The current reportable transaction rules in section 237.3 of the Income Tax Act (ITA), which were introduced in 2010, require a transaction to be reported if a two-part test is met.

First, the transaction must be an “avoidance transaction” as defined in the general anti-avoidance rule (GAAR). This definition covers any transaction that would result, directly or indirectly, in a tax benefit, unless the transaction may reasonably be considered to have been undertaken or arranged primarily for other valid purposes.

Second, the transaction must have two of the following three “hallmarks,” which were designed to identify certain types of potentially abusive tax avoidance transactions:

Fee hallmark – This hallmark applies if the fee related to an avoidance transaction is:

  • based on the amount of a tax benefit,
  • contingent on obtaining a tax benefit (or on failing to obtain a benefit), or
  • based on the number of persons involved in the transaction.

Confidential protection hallmark – This hallmark applies where an advisor obtains anything that would prohibit the disclosure of the avoidance transaction’s relevant details to any person or the CRA.

Contractual protection hallmark – This hallmark applies where the avoidance transaction:

  • includes insurance or other protection that protects against a transaction’s (or series of transactions’) failure to achieve a tax benefit (excluding standard professional liability insurance), or
  • provides for the payment or reimbursement of any expense, fee, tax, interest or penalty, etc., arising from a dispute over the transaction’s tax benefit.

We understand that only a relatively small number of disclosures have been made since the current rules were first introduced, and this is one of the key reasons why the government is broadening the rules.

Proposed changes to reportable transactions

The proposed rules would extend the definition of avoidance transaction to any transaction (or series) if it may reasonably be considered that obtaining a tax benefit is one of the main purposes. This is a broad definition, and our main concern is that this definition will catch any form of tax planning, even routine transactions that are well within the ITA’s object and spirit. For example, the proposals would consider incorporating a sole proprietorship, including a subsection 85(1) election, as an avoidance transaction.

The proposals also reduce the number of hallmarks that trigger reporting to just one.

Because so many transactions could potentially be in play due to the revised avoidance transaction definition, the Joint Committee raised the concern that the reporting net will be based mainly on the hallmarks. In particular, the Joint Committee identified issues with all three hallmarks that could cause bona fide commercial transactions or routine tax planning or practices to create a reporting requirement. Now that only one hallmark could create a disclosure requirement, these concerns are even more significant.

Concerns raised by the Joint Committee that are addressed in Bill C-47:

Effective date concerns – Under the revised proposals in Bill C-47, the reporting requirement and the penalty rules apply for transactions entered into after the date the legislation receives royal assent rather than January 1, 2022.

Short reporting timeline – Where transactions are reportable, the reporting must be done within 90 days (up from the previous 45-day timeline).

Joint and several liability for penalties – For reportable transactions, subsection 237.3(9) will be repealed given that multiple persons may be required to report. As such, taxpayers and their advisors will not have joint and/or several liability if another party does not report.

Contractual protection hallmark – Although the final version of this hallmark remains largely the same as the existing rules, a new exception was added to the proposed rules so that contractual protection related to an arm’s-length business sale will not trigger the contractual protection hallmark, provided that it is reasonable to consider that the insurance or protection is intended to ensure that the purchase price paid under the agreement takes into account any liabilities of the business immediately prior to the sale or transfer, and is obtained primarily for purposes other than to achieve any tax benefit from the transaction or series. Further, the rules continue to exclude standard professional liability insurance as contractual protection.

Fee hallmark concerns – The reportable transaction rules have been amended so that contingent fees related to Scientific Research and Experimental Development filings under subsection 37(11) will not trigger the fee hallmark. In addition, although no changes were made to the legislation, commentary has also been added to the explanatory notes to highlight that “value billing” and other similar billing practices will generally not trigger the fee hallmark. Reference should be made to the explanatory notes for further information.

Key concerns raised by the Joint Committee that are still outstanding:

Lack of materiality – The proposals do not include an element of materiality regarding the amount of the tax benefit or the amount of the fee under the fee hallmark.

Definition of advisor – The definition of “advisor” remains broad and includes each person who provides any assistance or advice for creating, developing, planning, organizing or implementing the transaction or series of transactions. For tax professionals performing subsequent tax compliance work such as tax return preparation, this would appear to not be included. However, the key will be whether assistance or advice was also provided when the transactions were entered into. This is important to keep in mind, as the latest proposals will repeal ITA subsection 237.3(4), which relieves reporting for all where one person reports, so each advisor that has a reporting requirement will have to ensure that they do report.

When determining whether an advisor has their own reporting requirement with respect to a reportable transaction, reference should be made to paragraph 237.3(2)(c). Under this paragraph (which is not amended), a reporting requirement for an advisor will exist where the advisor’s fee meets the conditions based on the fee hallmark or the contractual protection hallmark. If the fee does not meet these conditions, the advisor will not have their own reporting requirement even though there will still be a reporting requirement for the taxpayer. This rule will also assist in alleviating another concern that some expressed, being whether employees would have a reporting requirement of their own if they provide assistance or advice in respect of a reportable transaction.

Notifiable transactions

The 2021 federal budget introduced the concept of “notifiable transactions.” The proposal uses several concepts similar to the rules for reportable transactions, with proposed section 237.4 generally restating similar operative rules and definitions. For example, the definitions of “advisor” are similar under both rules, as are the deadlines for filing a disclosure.

A notifiable transaction is defined to be a transaction that is the same as, or substantially similar to, a designated transaction, or a transaction in a series of transactions that is the same as, or substantially similar to, a designated series of transactions.

A transaction or series is “substantially similar” to a designated transaction or series if:

  • the transaction or series leads to the same or similar “tax consequences”, and
  • it is either factually similar or based on the same or similar tax strategy

The legislation calls for the “substantially similar” requirement to be interpreted broadly in favour of disclosure.

Designated transactions will be set by the Minister of National Revenue, with the Minister of Finance’s agreement. A backgrounder released with the original draft legislation sets out six sample notifiable transactions. One sample, on manipulating the status of a Canadian-controlled private corporation, was also a focus of specific changes in Budget 2022 (see CPA Canada’s 2022 Federal Budget Tax Highlights). The backgrounder calls these “sample transactions;” however, it isn’t clear what the final designated transactions will be once the rules are in place.

In the final proposed rules, some of the reportable transaction issues highlighted above were also a concern under the notifiable transaction proposals and were addressed by Finance, such as the issues related to the effective date, reporting timeline and joint and several liability. On the flip side, some other concerns remain unresolved, such as the lack of materiality thresholds and the broad definition of an advisor (although some penalty relief provisions were added).

A specific concern related to notifiable transactions that was addressed in Bill C-47 related to the knowledge level of “secondary advisors” who provide assistance but are not involved with structuring the transaction or series as a whole. On this front, the exclusion that applied to the financial sector in the August 2022 draft legislation was replaced by a broader rule that will include advisors and other persons. Under Bill C-47, reporting will not be required in respect of a notifiable transaction, unless the person knows, or should reasonably be expected to know, that the transaction was a notifiable transaction. In addition, the taxpayer or persons entering into a transaction (or series) on the behalf of a taxpayer will not have to report if the person has exercised the degree of care, diligence and skill to determine whether a transaction is a notifiable transaction that a reasonably prudent person would have exercised in comparable circumstances.

Concerns raised by the Joint Committee on notifiable transactions that are still outstanding:

Process for designating transactions – The committee calls for a well-defined process for adding designated transactions to a list (beyond posting updates to the CRA’s website) and for removing ones that are no longer relevant. When a new transaction is added, sufficient lead time should be allowed for compliance.

Transactions with recurring benefits – Some transactions may provide benefits over more than one taxation year. The reporting process should minimize multiple filing requirements related to the same information.

Practical guidance needed – The reference to transactions that are “substantially similar” may cause confusion. Where possible, guidance should be provided similar to the CRA’s GAAR commentary in Information Circular 88-2.

Series of transactions – Applying the rules to a series is complicated because it might not be known from the series’ outset whether a reporting obligation will arise. It’s also possible that transactions in a series may be designated as notifiable after the series commences. The Committee suggested that a better trigger point for reporting would be at the time when the tax benefit is realized.

Uncertain tax treatments

The third component of the proposed changes would affect corporations that have recorded uncertain tax treatments (UTT) in their financial statements. These proposals would apply to a “reporting corporation,” which is defined as a corporation that:

  • has prepared “relevant financial statements” (basically, audited financial statements for the corporation or its consolidated group),
  • has assets with a total carrying value of $50 million or more at the end of the year, and
  • is required to file a return of income for the year under ITA section 150.

Note that private corporations would be subject to the rules if they meet these tests and if their financial statements are prepared in accordance with IFRS.

A UTT is a tax treatment used, or planned to be used, in a corporation’s income tax filings when it is uncertain that the tax treatment will be accepted as being in accordance with tax law and that uncertainty is reflected in the corporation’s (or its group’s) audited financial statements for the year.

An affected corporation would be required to file prescribed information on each of its UTTs for tax years starting after 2022. (As noted, however, no penalties would apply to tax years that begin before the legislation is enacted.)

Key concerns with uncertain tax treatments that remain outstanding

In CPA Canada’s submission to the government on these rules, we re-emphasized the key concerns that we raised as an intervenor before the Federal Court of Appeal in the BP Canada tax case regarding the CRA’s right to ask taxpayers for their tax accrual working papers (2017 FCA 61; see our earlier Tax Blog)  — that giving the CRA access to subjective information on tax risks without any safeguards may discourage corporations from preparing such analyses in the first place because they might have to disclose them.

The need for complete disclosure of tax risks by corporations to their external auditors in the context of their financial reporting obligations is crucial so that auditors can fulfil their responsibilities in the interest of the Canadian public.

As we submitted in BP Canada, a better way would be for Finance to require taxpayers to disclose material transactions but not any subjective risk assessments. Failing that, we recommended the proposed legislation should clearly indicate that:

  • UTT reporting requirements can be met by providing factual information only
  • reporting corporations would not be required to provide subjective tax information beyond identifying the individual UTTs

As part of our work in this area, we formed a group of members to provide us with feedback. Some technical concerns that they identified and that remain outstanding include the following:

Uncertainty of scope — Questions were raised about the rules’ scope, so we suggested several ways to clarify the definition of “reportable uncertain tax treatment.” For example, we recommended making it clear in the rules that they only require the reporting of Canadian income tax issues when the related uncertainty is reflected in the relevant financial statements.

Lack of de minimis threshold – In our submission, we pointed out that similar rules introduced in the United Kingdom and Australia include a de minimis test so that immaterial UTTs in the financial statements do not have to be disclosed. Adding such a rule to the Canadian regime would help reduce the compliance burden and minimize financial reporting concerns.

No reporting for known issues – Some UTTs will already be known to the CRA, such as those already subject to an objection or appeal. The proposals should be revised to align with the CRA’s general “tell us once” philosophy. Having to report the same information more than once in different ways is inefficient and adds costs.

We also raised concerns about issues such as functional currency reporting, inconsistencies for short taxation years, UTTs that offset in consolidated statements, and the need for multiple reporting where UTTs exist for more than one fiscal year.

We further recommended that, like the penalties, none of these new rules should be applied to years that begin before the legislation receives Royal Assent.

Finally, when all three components of the rules are considered, it becomes apparent that the same issue could trigger a reporting obligation under more than one component of the rules. Again, in line with the “tell us once” principle, a rule should be added to determine which reporting takes precedence as the single disclosure.

Watch for further developments

With the introduction of what are assumed to be final rules, we will be communicating issues and questions in respect of the new rules to the CRA. Updates will also be provided as new information becomes available, so watch our Canadian Tax News page for developments.

Article by CPA Canada

Other Posts