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INCOME TAX LAW: General Anti-Avoidance Rule

The GAAR:  Overriding, Overarching or Just Over?

In most legal structures, rules and regulations tend to expressly or implicitly instruct or guide a person or any other legal entity for that matter, on how to conduct its affairs internally or externally (in regards to the public).  Further, with the passage of time, courts, regulatory bodies and the legislator have provided guiding principles, where necessary, on how to apply, effect and interpret these rules and regulations in accordance with the intent and purpose of their creators.  Much too often does it become difficult to distinguish doctrine from rule and vice versa as well as adjudicating between the competing interests a rule and a complimentary principle both have to offer.  It is at that point where the strength of the stallion pulls its public policy interests within those principles all the way to the legislator, usually resulting in a reform, repeal or expansion of the current applicable law or the creation of a new one.  The law created through these means and ways are more precise and accurate in dealing with a dispute or issue.  Further, by virtue of the way they came into being, the purpose, effect and application of these newly created rules are easily attainable and justified through a textual, contextual and purposive approach, with little room for doubt and uncertainty.  Essentially, the legislator and regulatory bodies provided a pinpointing solution to a problem that had been in incubation within our legal system.  The rules premised on their pinpointing accuracy harness a more precisely applicable environment for it to exist in.  However, what happens when a rule is created in a general format, with little accuracy and precision of its applicability, where the rule itself is a mere outline of vaguely guiding instructions on how to apply it.  A rule that was created in expansion to a much larger scheme of rules, designed to reinforce the capacity of these other rules on a case by case, issue by issue basis; perhaps a lazy solution to encapsulating a continually growing stew of problems.  Or is the nature of the scheme of rules for which this expansion applies to, of the type that necessitated the addition of such a generally applicable rule.  Was it the nature of the type of law and its jurisprudence that requisitioned such a rule or was it the only way to engrave the competing interests of the applicable policy concerns resulting from the continually cooking stew of issues?

Since 1987 it has been quite difficult to place parliament’s intent for the purpose, effect and application of the General Anti-Avoidance Rule, section 245, in the Income Tax Act (“the Act”).  After continually expanding the Act with specific anti-avoidance rules every time an abuse or misuse of the Act was transacted not in line with the original intent of the legislator, Parliament decides to create an all encompassing anti-avoidance regime within the Act.  This was in reaction to watching the erosion of the tax base as the continual process of action and reaction produced by the introduction of specific tax measures led to an even stronger and ever growing aggressive response by taxpayers in attempting to avoid such measures[1].

The very nature of the Act necessitated such a generally applicable anti-avoidance rule.  The Act is not like any other in the Canadian legal system.  It is not criminal but it has the same punitive powers, it is not entirely administrative and regulatory as it is a voluntary self assessing statute applicable to every person and type of legal entity, and it is not like civil law since it does not require one to do or not to do onto another, except in cross-border transactions, but rather how to account and not to account for transactions necessary for the government to know.  The Act is a recipe for unpredictability, allowing the taxpayers the voluntary right to challenge their own self assessment in accordance with the rules.  This results in sophisticated strategies that often involve the combined or serial application of various technical provisions to yield unintended tax advantages.[2] Further, how does one assess one’s own accountability and liability in taking the challenge when the only things working against that person or entity are general counteracting vague provisions in a voluntary regime?  Thus, in order for the Act to remain voluntary, self assessing and adaptively growing, while premised on the underlying principles of fairness and equity, it must be flexible, accommodating, and perceptive at the same time.

After taking into consideration the policy concerns of equity and fairness along with the erosion of the tax base through the continual unintended use, misuse and abuse of the provisions of the Act by the more technically savvy taxpayers, and balancing it with the need to be flexible, accommodating and perceptive to all taxpayers and their purposes for transacting in certain ways, a vague set of curtailing provisions left up to interpretation on a case by case basis was the only answer.  The GAAR is not and was not intended to be an overriding principle or rule however it is an overarching one, in that the objective of the GAAR is to ensure that it would only be applied to sufficiently abusive tax planning once all other provisions in the Act to curtail avoidance behaviors had been exhausted.

Thus, the purpose, effect and application of the GAAR is difficult to pinpoint on a consistent basis.  This difficulty is by virtue of the GAAR’s need to be an adaptive charging provision on a case by case and issue by issue basis.  In that it compromises predictability of the Act in order to retain its perceptive need to adapt to the interplay between the Act and the right for taxpayers to challenge the Act by arranging their affairs in ways best suited to their (the taxpayers’) capacity to pay.[3] As a result, the modern day purpose and application of the GAAR is effected by the courts as a function of a variety of interpretative factors including their past approach to statutory interpretation and tax avoidance transactions prior to the GAAR; the ways and means from which the GAAR was developed into being; the GAAR Committee’s original justification; how the CRA has come to apply it; the way the Crown counsel considers the GAAR; how practitioners litigate their position on the application of the GAAR; and the case by case and issue by issue basis that have created the source of common law jurisprudence/authority relied upon today.[4]

Prior to the GAAR, the Crown was most frustrated with the court’s unwillingness to apply the purposive approach to the Act when adjudicating alleged tax avoidance schemes.  However, the turning point seemed to reach its high ground in Stubart.[5] Although not exactly what the Crown had hoped for, the Supreme Court had expressly adopted a purposive test to interpreting the Act.  However, the type of purposive interpretation was not sufficient to put substance over form as the Crown had urged.  Thus, after realizing the courts’ continual reaffirmation of the principles laid out in the Duke of Westminster case and the lack of recognizing a business purpose test, the Crown came to terms with the fact that they could not be successful in cases involving what they had considered abusive tax avoidance without a substantive law (i.e. a statutory provision).  As a result the Government adopted the GAAR, originally intended to curtail abusive tax avoidance schemes by integrating the much anticipated business purpose test.

It wasn’t very long before the courts’ realized that the original language of the GAAR was overly broad in its interpretation and as a result, at times, overriding when applying its principled approach.  This gave the MNR a lot of leverage from its new discretionary power to prevent what it had concluded as a misuse, abuse or even as lax as an unintended use of the provisions in the Act by taxpayers.  Thus, after much objection by the tax community, the onus was left on the GAAR committee to find the proper balance between preventing an abusive application of the GAAR by the MNR and an abuse of the provisions of the Act by the taxpayers and their tax planning schemes.  The committee had advocated to ensure that the GAAR was a provision of last resort after an exhaustion of all other specific anti-avoidance rules in the Act had been applied to sufficiently abusive tax avoidance transactions.  However, this power, in itself, to control the review and application of the GAAR on a case by case basis – although it meant greater uniformity – it involved too may of the higher levels of governmental departments often creating an impenetrable authority over what cases should and shouldn’t be subjected to GAAR.  And thus, once applied, it consequently meant that to dispute would require a trial.

With time the underlying issue in the application of the GAAR faced by all those in adjudicating such cases is that despite the GAAR, taxpayers must have the right to select the transaction or set of transactions that will result in the least amount of tax.  That is, taxpayers must have the choice to conduct their affairs in a way that would result in the least amount of tax consequences, which can also be thought of as a right to have the power to somewhat commensurate (and justify) one’s own ability to pay with what they desire to forego from their income.  Therefore, a business purpose test through the application of the GAAR would surely violate this right in every case premised on circumstances other than commercial relatedness.  As well, the broad definition of an avoidance transaction would preclude virtually all tax planning in commercial transactions.[6] As a result, subsection 245(4) of the Act broadened the test to that of a requisitioned or need for transactions with a real economic substance, thereby narrowing the GAAR’s reach by drawing the line between transactions that undermine the dominant policy of the Act and those that do not.[7] The balance between the doctrine set-out in Westminsterand the GAAR’s notion of “tax-motivated” transactions was met with the limitation on its application through the equivocal interpretation requiring real economic substance relatedness even if it is tax motivated.  Thus, for example, where estate planning can purely be for tax motivated reasons – strictly in-line with the provisions and in tune with the purpose or intentions of the Act – if the requisite element of real economic substance is met, subsection 245(4) of the Act saves the transaction or transactions.  In other words and as it should be, estate tax planning is not considered an abuse or misuse of the provisions of the Act.  And this example is just one of the many reasons to tame the discretionary latitude granted by the GAAR and in keeping with the principle of Westminster and the like.

There is no predictability and certainty as to how a case, scheme, issue, or plan will be determined.  For there are no certain principles or conventions used in deciding whether a transaction or set of transactions are in line with the Act as a whole and consistent with Parliament’s purpose or if it or they are in actuality frustrating the relevant provisions of the Act through a “misuse or abuse”.  Stretching it even thinner is that what is abusive is left open for interpretation.  Thus far, successful GAAR applications have been seen in cases where real economic substance should have ordinarily limit the true or intended use of the provisions relied upon in creating that plan.  And in that, the taxpayer clearly contradicted the intentions of historic and present, generally accepted tax principles in areas where the options for accounting of that transaction or set of transactions are not too technical or complex.  By virtue of its path of creation and its introduction and development into modern day jurisprudence, the vaguely guiding set of statutory instructions on anti-avoidance remain broadly interpreted and yet limited in discretional application and effect.  Entirely, it is all in light of keeping with the need to find balance between the doctrine set-out in Westminster and the GAAR’s notion of “tax-motivated” transactions; between preventing an abusive application of the GAAR by the MNR and an abuse of the provisions of the Act by the taxpayers and their tax planning schemes; and in order to retain the Acts perceptive need to adapt to the interplay between the Act and the right for taxpayers to challenge the Act by arranging their affairs in ways best suited to their (the taxpayers’) capacity to pay.  Given the aforementioned and the knowledge of it, one would find it hard to say with certainty whether or not the GAAR is an effective tool against, let alone the answer to, abusive tax avoidance in Canada.

Don’t lose out because you weren’t prepared.  Call the lawyers at Levy Zavet PC in Toronto, Ontario, Canada for information and assistance regarding your tax law rights and obligations.

[1] Honorable M.H. Wilson on “Tabling of a Notice of Ways and Means Motion to Amend the Income Tax Act,” Canada, Department of Finance, December 16, 1987.

[2] Canada, Department of Finance, The White Paper:  Tax Reform 1987, Ottawa: Finance, June 18, 1987.

[3] IRC v. Westminster, [1936] A.C.1 (H.L.).

[4]Erlichman, Harry, Tax Avoidance in Canada:  The General Anti-Avoidance Rule, Toronto, Ontario, 2002, Irwin Law Inc.

[5] Stubart Investments Ltd. V. Canada, 84 D.T.C. 6305 (S.C.C.).

[6] Krishna, Vern, International Guide To Advance Ruling Canada, CGA Ontario Tax and International Business Research Centres, University of Ottawa, 1997.

[7] Ibid.