Understanding Anti-Avoidance Rules In Canadian Tax Law

Canada has relatively high taxes compared to some other countries. While taxes are difficult and, in most cases, illegal to avoid, there are many strategies Canadians use to keep most of their hard-earned income. However, there is a fine line between implementing legitimate business or personal tax strategies to reduce your tax bill and violating the anti-avoidance rules. The consequences of non-compliance with the Canadian tax law can result in serious repercussions, including additional taxation and legal fees. The tax lawyer at Jeremy Scott Law can help you explore the tax-saving strategies available to you and explain everything you need to know about the general anti-avoidance rule in Canada. Call (902) 403-7201 to schedule a case evaluation of your tax situation.

What Is the General Anti-Avoidance Rule in Canada?

The Westminster principle is the foundation of Canadian law on tax planning. Under this principle, taxpayers in Canada are entitled to arrange their financial affairs in a way that would allow them to pay the least amount of taxes possible. While Canada’s judicial system continues to recognize the Westminster principle as valid, individual tax planning abilities may be severely limited by the Income Tax Act (ITA) and, more specifically, the General Anti Avoidance Rule (GAAR), which is found in Subsection 245(2) of the ITA.

Some Canadian taxpayers may feel that the GAAR undermines the essence of tax planning due to the restrictions it imposes on their ability to order their affairs in such a way as to lower their tax burden. The GAAR applies to the Canadian tax law in its entirety, not to specific actions or parts of the taxing statute. The anti-avoidance rules allow the Canada Revenue Agency (CRA) to impose the adverse tax consequences of otherwise valid tax planning when specific criteria – also known as “pre-conditions” – are met.

A Three-Step Test for the Application of the General Anti-Avoidance Rule

The GAAR only applies under certain circumstances, and only when the CRA can prove abusive tax dodging. The government uses a set of so-called “pre-conditions” that can be summarized as a three-step test. If the following questions are answered in the affirmative, the general anti-avoidance rule is likely to apply:

1. Did a particular event or transaction result in a tax benefit to the taxpayer in question?
2. Was this event or transaction an “avoidance transaction”?
3. Did the taxpayer misuse or abuse the tax statute or any of its particular provisions when conducting the avoidance transaction that gave rise to the tax benefit?

In the vast majority of cases where the CRA suspects abusive tax planning, the most challenging part is proving the second and third conditions of the three-point test. In such cases, the CRA has the burden to prove misuse or abuse on the part of the taxpayer, while the taxpayer has a right to defend himself or herself in the event of a tax audit or court battle. If you are being investigated by the CRA on the matter of violating anti-avoidance rules, you might want to consult with a tax lawyer. Jeremy Scott Law may be able to review the facts of your case to determine your best course of action when facing allegations of tax avoidance or tax evasion.

How Does the General Anti-Avoidance Rule Apply to Businesses?

In general, this rule does not apply to business transactions. However, there is one area in which GAAR may confuse small business owners and make them wonder if they are doing something wrong: sales tax. Canadian goods and services tax (GST) and harmonized sales tax (HST) are only required to be paid if a small business is not a small supplier as defined by the Canada Revenue Agency. If a business is a small supplier, they do not have to register even if they make sales, leases or other supplies that are taxable. This voluntary registration may make those businesses who opt not to register question if they might be violating GAAR. If small suppliers do opt to register, the GST and HST rates are defined by the Retail Council of Canada.

Tax Planning vs. Tax Avoidance vs. Tax Evasion

Many Canadians who file taxes do not understand the distinctions the CRA makes among tax planning, tax avoidance, and tax evasion. While tax planning is permitted by Canadian tax law, the same cannot be said about abusive tax avoidance or tax evasion, which can lead to criminal charges and stiff penalties. If the CRA can prove tax avoidance under the GAAR, the taxpayer’s tax benefits can be denied. According to the official website of the Government of Canada, taxpayers convicted of tax evasion can be:

• Ordered to pay the full amount of taxes owed
• Ordered to pay interest and civil penalty
• Fined up to 200% of the taxes evaded
• Sentenced to jail for up to five years

Tax avoidance, in and of itself, is not the same as tax evasion. A taxpayer commits tax evasion when they purposefully and unlawfully attempt to evade the assessment or payment of taxes imposed by the government. Under the law, tax avoidance is not always abusive or fraudulent. As a rule of thumb, transactions made primarily for a valid economic or commercial purpose rather than a tax reason are not considered an “avoidance transaction” under the GAAR. In addition, it is generally not an abuse or misuse of the tax statute if the outcome of the transaction matches the policy promoted by the tax law. However, many situations may not be as clear-cut, potentially resulting in a legal battle between the taxpayer and the CRA.

Avoiding the General Anti-Avoidance Rule (GAAR)

While it is true that a judge can use the GAAR to deny benefits and invalidate avoidance transactions, you should keep in mind that you – as a taxpayer – have a right to arrange your affairs in a way that allows you to minimize your tax liability under the Westminster principle. In addition, when implementing tax planning strategies, there are certain things you can do to avoid or limit the possibility of the CRA investigating you for violating anti-avoidance rules:

1. Always plan the steps required for an upcoming transaction beforehand so that you do not need to take any additional steps after the transaction is complete (any post-transaction steps are usually subject to scrutiny under the GAAR).
2. Avoid any intermediate steps when trying to reach the desired outcome as the CRA usually pays very close attention to these types of transactions.
3. Focus on both the tax and non-tax purposes of a transaction as transactions made primarily for tax reasons may trigger the GAAR.
4. Consider seeking legal advice from a tax lawyer when in doubt as to whether or not a particular transaction could be perceived by the CRA as tax avoidance.

Many taxpayers often misinterpret the statutes contained in Canadian tax law and do not fully understand the scope of the GAAR. For this reason, you might want to consider speaking with a knowledgeable tax lawyer to get a personalized and effective tax plan to steer clear of tax audits triggered by an alleged violation of anti-avoidance rules.

The Professional Tax Guidance You Can Trust

The line between tax planning and tax avoidance is often blurred. As a taxpayer, you may find yourself in the crosshairs of the CRA even if you think you have complied with Canadian tax law and did nothing to abuse the system. Jeremy Scott Law may be able to explain the anti-avoidance rules and how they apply to your situation. The law firm might be able to provide you with the professional tax guidance you need to arrange all your tax matters in a legal and confident way. Call (902) 403-7201 to schedule a case evaluation with our tax lawyer.