Tax laws are a complex system of rules resulting from legal and accounting provisions. As with many systems, creative individuals can use their technical expertise for good or bad purposes. The general anti-avoidance rule was adopted to prevent abusive operations. This notion in itself is quite subjective though which creates a relative uncertainty as to what should be considered abusive.
General and specific rules
The complexity of tax laws yields tax planning that although it respects the wording of the law, it contravenes its spirit. Thus both the federal and the Québec tax law contain anti-avoidance provisions that are either specific or general.
Specific rules concern expressly transactions or series of transactions which give a result specifically mentioned in the law. Let’s say that the law prevents deduction of interest that surpasses a certain rate. If someone devises a system whereby a series of transactions results in a deduction superior to the prescribed rate, then the specific anti-avoidance would prevent such a result.
The general anti-avoidance rule goes much further. Although each transaction of a series can be legal, the question to answer is whether the series of transactions as a whole violated the tax laws as being abusive.
Canada Trustco Mortgage Co v Canada, [2005] 2 SCR 601
The Supreme Court of Canada analyzed the provisions of the Income Tax Act of Canada in Trustco and established a three steps analysis to apply the general anti-avoidance rule of Canada’s Income Tax Act.
Canada Trustco specifies that the three requirements for denying a tax benefit under the GAAR are: (1) the benefit arises from a transaction, (2) the transaction is an avoidance transaction as defined in s. 245(3), and (3) the transaction results in an abuse and misuse within the meaning of s. 245(4).
"Tax benefit" is defined to mean a reduction, avoidance or deferral of tax or other amount payable or an increase in a refund of tax or other amount under the Act.
An avoidance transaction is defined in subsection 245(3) as a single transaction or one that is a part of a series of transactions where the single transaction or the series results directly or indirectly in a tax benefit, unless the transaction is carried out primarily for bona fide purposes other than to obtain the tax benefit.
Finally, the transaction or series of transactions must result in a misuse or abuse of the law. In Trustco, the Court said that there is abuse when the end result of the planning goes against the initial purpose of the invoked provisions themselves.
The above test is extremely vague, and both sides can usually be argued extremely well. If the CRA claims that a taxpayer is in violation of the GAAR, it will be up to the taxpayer to prove they are not. On that same note, the CRA must prove that the GAAR applies.
Last Resort
There is an elaborate administrative process inside CRA regarding the application or potential application of the GAAR. It goes from an auditor to the Aggressive Tax Planning Division, and the GAAR Committee.
The GAAR Committee comprises members from the CRA, Department of Finance and Department of Justice. The GAAR Committee meets periodically to consider the referrals. The Committee members consider the file beforehand, and the meetings allow the committee members to discuss and develop a view on the matter.
The potential application of GAAR in a specific case is very fact-dependent. The jurisprudence on the legal analysis continues to evolve. The focus remains on how to interpret the “misuse and abuse” test within section 245.
