There are many anti-avoidance rules under the Income Tax Act. Most of them are “specific” anti-avoidance rules because they target specific tax avoidance schemes and transactions. For example, the income attribution rules prevent you from splitting income with your family members in certain circumstances. (We have discussed the income attribution rules before and will summarize them again in a future Tax Letter.)
On top of those specific rules, there is a general anti-avoidance rule (GAAR), which can potentially apply to any transaction or event that circumvents the general scheme and intent of the Income Tax Act.
If GAAR applies, the results of your transaction or scheme can be re-characterized to whatever is “reasonable in the circumstances”, which means you will pay more tax than you planned. The Canada Revenue Agency, or ultimately the courts, can use this rule to reduce a deduction, increase an inclusion, or reduce a credit, and they can use the rule for other detrimental purposes for taxpayers if GAAR applies.
So when does the GAAR apply?
First, there must be an “avoidance transaction”. This means a transaction or event that results, directly or indirectly, in you receiving a tax benefit – which can include, among other things, an additional income inclusion, a reduction in your deductions, or more generally a reduction in your tax payable (including future tax payable, under a proposed amendment to GAAR that will apply retroactively). But the transaction is not an avoidance transaction if you can show that the transaction or event was undertaken or arranged primarily for bona fide purposes other than to obtain the tax benefit. Generally, if you can show that the transaction or event was primarily for business, investment, or personal purposes, and not to get the tax benefit, you will not be subject to GAAR.
An avoidance transaction also includes a transaction or event that is part of a series of transactions or events, where the series results in you receiving a tax benefit. This rule significantly broadens the concept of an avoidance transaction, because even if the transaction itself does not result in a tax benefit, if the series results in a tax benefit, you can still get caught under GAAR. Again, there is an exception where GAAR does not apply, in that the transaction is not an avoidance transaction if you can show that the transaction was considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain the tax benefit.
Luckily, there is also an overriding provision. It says GAAR applies only if the transaction or scheme results in a “misuse” of specific provisions of the Income Tax Act or other tax laws, or an “abuse” of those rules.
On the downside, this “misuse or abuse” provision is difficult to interpret in many situations, and requires a tax lawyer or other tax expert to provide guidance. And even then, if the case eventually makes it to the courts, it is up to the judges to decide on whether GAAR applies.
