Canada: Quebec Releases Consultation Paper On “Aggressive Tax Planning”

Copyright 2009, Blake, Cassels & Graydon LLP

Originally published in Blakes Bulletin on Tax, February 2009

The Minister of Finance of Quebec (Finance Quebec) recently released a discussion paper (the Green Paper) on so-called "aggressive tax planning" (ATP).

The Green Paper was issued further to Finance Quebec's announcement in the Quebec 2008-2009 Budget Speech in March 2008 (see our March 2008 Blakes Bulletin on Tax: Quebec Budget Highlights – Certain Measures Concerning Businesses). In that announcement, Finance Quebec stated that a review of Quebec tax legislation was required to address ATP. The full text of the Green Paper is available at http://www.finances.gouv.qc.ca.

In this bulletin, we briefly describe the proposals referred to in the Green Paper and provide some initial comments on these proposals.

Finance Quebec asserts that it released the Green Paper in order to "consult" with the tax community. The deadline for submissions was stated to be March 1, 2009, although Finance Quebec subsequently extended the deadline to April 1, 2009.

POSSIBLE LEGISLATIVE CHANGES

Finance Quebec's focus in the Green Paper is on detection and deterrence of so-called aggressive transactions. Finance Quebec asserts that the downside risks faced by a taxpayer whose transaction is successfully challenged are not significant enough, and therefore proposes significant new penalties. As well, Finance Quebec proposes both mandatory and voluntary disclosure requirements, and an extension of the limitation period before which a tax year becomes statute-barred in some cases. There is also a proposal to amend the Quebec general anti-avoidance rule (GAAR) to "clarify" that it applies to abusive federal and inter-provincial tax avoidance transactions.

Mandatory Early Disclosure Mechanism

Under new rules, taxpayers would be required to notify the Quebec tax authorities, using a prescribed form (Early Disclosure Form) in connection with certain types of transactions. These rules are based upon regulations under the United States Internal Revenue Code (the U.S. Code) that require disclosure of certain reportable transactions.

The notification would apply only where:

• a taxpayer enters into a "confidential transaction", i.e., where the taxpayer retains the services of an "advisor", under a contract that includes an undertaking of confidentiality by the taxpayer towards other persons or the tax administration in relation to the transaction; or

• the remuneration of the advisor is, in whole or in part (i) contingent upon the taxpayer obtaining a tax benefit or depends on the amount of such tax benefit, (ii) refundable to the taxpayer if the expected tax benefit does not materialize, or (iii) earned only after the relevant year becomes statute-barred.

In effect, the mandatory filing applies only to marketed tax structures and contingent fee situations. Failure to file the Early Disclosure Form on time results in imposition of a penalty of between C$10,000 and C$100,000. As well, the normal limitation period is suspended, effectively keeping the tax year open for reassessment indefinitely.

In view of the limited scope of the mandatory notification – it applies only to marketed tax structures and contingent fee arrangements – the impact of this proposal will be relatively limited. The Early Disclosure Form must be filed within 30 days after the transaction "begins to be carried out". It is not clear whether this is intended to mean signing or closing of a transaction. In any case, this is an extremely short time period. In contrast, the regulations under the U.S. Code only require reporting in a taxpayer's tax return, after a transaction has been undertaken.

The quantum of the penalty – C$100,000 at most – suggests that the real target of this measure is tax structures marketed to individuals and private companies, rather than more complex financial and other transactions involving substantial tax savings.

Changes to Quebec's GAAR

It is proposed that the Quebec GAAR be amended so that it would apply not only to transactions that avoid Quebec tax, but also to transactions that avoid other Canadian federal or provincial tax. The expansion of the Quebec GAAR to apply to transactions that avoid Canadian federal or provincial tax seems inappropriate and opportunistic. The aggrieved tax jurisdiction would be the federal or provincial jurisdiction whose taxes were avoided. The application of the federal and/or another provincial GAAR in addition to the Quebec GAAR could result in double or triple taxation. This is nothing short of a windfall to the Quebec government, which cannot be justified on any basis.

While not entirely clear, it seems this change is intended to be retroactive. In light of the recent OGT Holdings case, dealing with interprovincial planning, it is arguable that this change is not needed in any event, as both the Quebec court and the Quebec Court of Appeal in that case applied Quebec's GAAR to a transaction that arguably avoided Ontario – not Quebec – tax.

The Green Paper includes a lengthy discussion of a possible unilateral change to GAAR to add the concept of "economic substance". Supportive comments from academics are cited, but the Green Paper ultimately rejects such a proposal on the grounds that such a change would differentiate Quebec GAAR from federal GAAR. Evidently, Finance Quebec does not wish to allow substantive Quebec tax law to differ from federal law, despite assertions to the contrary elsewhere in the Green Paper.

Extended Reassessment Period for Quebec GAAR

Normally, a tax year becomes closed for reassessment once four years have run since the mailing of the original assessment for the year. Shorter periods apply to individuals and some private companies.

Longer periods apply for transfer pricing and certain other types of adjustments. The Green Paper proposes a similar extended period (by an additional three years) where Quebec GAAR is applied. This longer period would not apply if the taxpayer elects to disclose such transaction to Revenue Quebec. While in theory such disclosure might be made, it is difficult to imagine a situation in practice where this would occur. Also, the longer period would not apply if the Early Disclosure Form is required and is in fact filed on a timely basis.

This proposal is unfair having regard to the very uncertain nature of GAAR as recently evidenced by the Supreme Court of Canada decision in Lipson (see our January 2009 Blakes Bulletin on Tax: Supreme Court of Canada Finds Against Taxpayer in Lipson but with Positive Comments on GAAR Approach). Moreover, having a limitation period which is out of step with the accepted limitation periods of the federal Income Tax Act and the laws of other provinces will create the potential for double taxation. This is unwarranted and is extremely unfair.

Enhanced Penalties

In a move that is likely to prove controversial, the Green Paper proposes significant new penalties where GAAR is successfully applied.

Where GAAR is successfully applied, the taxpayer would face a penalty equal to 25% of the additional tax payable. The penalty could be avoided if:

• the taxpayer discloses the transaction to Revenue Quebec by the due date for the relevant tax return for the year in which the transaction closes; or

• the taxpayer submits a successful defence of due diligence.

Realistically, the likelihood that a taxpayer who has engaged in tax planning will notify Revenue Quebec that GAAR could apply seems remote. This is particularly so having regard to the uncertain nature of GAAR which is a facts and circumstances determination. A taxpayer would not want to concede that a transaction might give rise to so-called "abusive tax avoidance". In essence, therefore, the penalty proposal is really no more than an increase in the "downside" faced by a taxpayer whose transaction is judged "abusive". While it is perhaps understandable that a tax authority would want to have such additional weapons in its arsenal in order to deter so-called "aggressive" planning, the suggestion that taxpayers can avoid penalties by flagging their transactions for Revenue Quebec seems disingenuous.

The Green Paper leaves unanswered the question of what steps a taxpayer would need to take to comply with the due diligence defence. It is unclear whether the receipt of a professional opinion supporting the taxpayer's filing position would be sufficient.

Penalties are proposed not only for the relevant tax-payer, but also for the "promoter". For this purpose, a promoter of a tax structure is defined as a person who:

• markets or promotes an "abusive avoidance transaction" or otherwise encourages its growth or the interest it arouses – for this purpose, abusive tax avoidance is considered to exist where the transaction is held to be subject to Quebec GAAR;

• receives, directly or indirectly, consideration in respect of marketing, promotion or encouragement of an "abusive avoidance transaction"; and

• has a substantial role in respect of marketing, promotion or encouragement of an "abusive avoidance transaction".

A promoter faces a penalty of 12.5% of its related fees. This raises serious issues for taxpayers and their advisors. Taxpayers should be able to freely seek tax advice, and advisors should be able to provide such advice without fear of imposition of penalties. If the taxpayer is penalized and its advisor is a "promoter", it appears that promoter penalties follow automatically. There may well be circumstances where a tax advisor will have difficulty disproving an allegation that it is a "promoter" without violating client confidentiality obligations.

The proposals to add penalties where GAAR is successfully applied are clearly out of step with the Supreme Court of Canada's comments in Lipson, in which the court stated:

To the extent that it may not always be obvious whether the purpose of a provision is frustrated by an avoidance transaction, the GAAR may introduce a degree of uncertainty into tax planning, but such uncertainty is inherent in all situations in which the law must be applied to unique facts. The GAAR is neither a penal provision nor a hammer to pound taxpayers into submission. It is designed, in the complex context of the [federal Income Tax Act], to restrain abusive tax avoidance and to make sure that the fairness of the tax system is preserved. A desire to avoid uncertainty cannot justify ignoring a provision of the [federal Income Tax Act] that is clearly intended to apply to transactions that would otherwise be valid on their face.

We believe such penalties are inappropriate and should not be included in the proposed legislative changes.

Comments on Retroactive Legislation

Perhaps the most controversial portion of the Green Paper is the allegation that the use of retroactive legislation is a necessary and appropriate tool to combat aggressive tax avoidance.

One of the arguments supporting this is the suggestion that retroactive changes merely "clarify" the rules. Experience shows that in fact such changes go well beyond "clarification" and retroactively impose new taxes in circumstances where the existing legislation clearly did not provide for it. In MIL Investments, a judge of the Tax Court of Canada commented on retroactive legislation as follows:

Retroactive legislation, although within the power of Parliament is legal but undesirable... The inappropriateness of reassessing taxpayers who completed transactions in accordance with the law in force at the time of those transactions without any expectation of adverse retroactive effect is self-evident.

(See our October 2007 Blakes Bulletin on Tax: Unsuccessful Crown Attempt to Apply GAAR to the Canada–Luxembourg Tax Treaty for more on the MIL Investments decision.)

OBSERVATIONS

The Green Paper proposes to give Revenue Quebec new statutory tools to deal with so–called "abusive tax avoidance transactions". These transactions are referred to as transactions that comply with the letter of the tax law but allegedly abuse the "object, spirit and purpose" of the tax legislation.

The extensive discussion in the Green Paper ignores the most serious problem with this formulation – which is the fact that "abuse" is an extremely subjective and uncertain concept. Indeed, in the recent Lipson case in the Supreme Court of Canada, three distinct views were taken by different members of the court on this question. Unfortunately, the rigour of the court's analysis in this area is often questionable. In many cases the determination of "abuse" arguably boils down to little more than a "smell test". The Green Paper states that there must be "clear abuse" in order for GAAR to apply, that "benefit of the doubt" goes to the taxpayer and, for that reason, tax authorities are "very cautious" in applying the GAAR. This remains to be seen. The imposition of harsh new penalties would encourage the tax authority to challenge a wider range of transactions knowing that the taxpayer will be more likely to settle where the downside of losing has been increased.

The sweeping nature of the proposals may explain why Finance Quebec has invited the tax community to provide comments. There can be no doubt that these provocative proposals will result in considerable comment. Undoubtedly, the other Canadian tax authorities are monitoring the developments with interest. Even if the other authorities do not adopt the same approach, if Quebec goes ahead, the other authorities will undoubtedly be beneficiaries through their existing exchange of information arrangements.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.