An Update on the Mandatory Disclosure Rules

An Update on the Mandatory Disclosure Rules

The implementation of changes to the Mandatory Disclosure Rules as proposed in the 2021 federal budget continues to be a multi-year process. The proposed changes include broadening the scope of the existing reportable transaction rules, enacting notifiable transaction rules and enacting uncertain tax treatment rules. Recently, the government renewed its commitment to implementing the proposed rules, but their coming into force has mixed timing. The Department of Finance (Finance) proposes that the reporting of uncertain tax treatments have an earlier coming into force date, applying to tax years beginning after 2022, while the other proposed disclosure rules will come into force when a bill implementing the legislation receives Royal Assent. This mixed timing will have different implications for taxpayers entering into transactions in 2023.

Brief Legislative History of the Changes to the Mandatory Disclosure Rules

The 2021 Budget proposed changes to the Mandatory Disclosure Rules to address the lack of timely, comprehensive and relevant information on aggressive tax planning strategies, stating that early access to this information allows tax authorities to respond quickly through informed risk assessments, audits and changes to legislation. The 2021 Budget also indicated that the Income Tax Act’s existing reportable transaction legislation was not sufficiently robust to address the above concerns.

The 2021 Budget announcement of changes to the Mandatory Disclosure Rules was followed by a series of public consultations with draft legislative proposals released in February and August of 2022. It was anticipated that a bill before the end of 2022 would include the proposed changes to the Mandatory Disclosure Rules. While Bill C-32 contained other outstanding legislative measures announced in the 2021 and 2022 federal budgets, the Mandatory Disclosure Rules were not included. However, the 2022 Fall Economic Statement confirmed the government’s intention to implement changes to the Mandatory Disclosure Rules. In conjunction with the economic statement, Finance clarified that the coming into force dates would be mixed. For the enactment of the rules relating to notifiable transactions and the changes to the rules relating to reportable transactions, the coming into force date is delayed until a bill implementing the legislation receives Royal Assent. For the rules relating to uncertain tax treatments, Finance maintained that these rules would apply to taxation years beginning after 2022 (except for associated penalties which will apply only after Royal Assent). Finance aims to use the delay to assess the feedback received from the public consultations on the proposed changes to the rules.

Mandatory Disclosure Rules

The Mandatory Disclosure Rules require reporting of three types of information: i) reportable transactions (transactions that exhibit defined “hallmarks” of aggressive tax planning strategies), ii) notifiable transactions (certain aggressive tax planning strategies as identified by the CRA and transactions of interest for the CRA), and iii) uncertain tax treatments (reserves recorded for tax positions taken). Included in the rules are provisions to extend the normal reassessment period and to impose penalties for failure to report. As well, for reportable transactions and notifiable transactions, the rules contain specific provisions applicable to promotors and advisors requiring reporting and imposing penalties for failure to report.[1]

Reportable Transactions

At a high-level, the existing Mandatory Disclosure Rules provide that a reportable transaction must be disclosed on or before June 30 of the following calendar year if it is or contains an avoidance transaction and two of three defined generic hallmarks are present.

Under the proposed rules, a transaction under this category is reportable within 45 days of entering into the transaction if it is or contains an avoidance transaction and any one or more of the following three generic hallmarks are present:

• Contingent fee arrangement
• Confidential protection (related to the tax treatment of an avoidance transaction)
• Contractual protection (excluding those in a normal arm’s-length commercial or investment context and that do not extend protection for a tax treatment).

In addition to reducing the number of generic hallmarks required for the disclosure of a reportable transaction, the proposed changes broaden the scope of the existing rules by modifying the definition of “avoidance transaction”. For purposes of the reportable transactions rules, an “avoidance transaction” is no longer defined solely by reference to the GAAR provisions (a transaction that would result in a tax benefit, unless it has been undertaken primarily for bona fide purposes other than to obtain the tax benefit), but is a transaction where it can reasonably be considered that one of the main purposes is to obtain a tax benefit.

Notifiable Transactions

The draft legislation provides that a transaction under this category is reportable within 45 days of entering into the transaction if it is the same as or substantially similar to a transaction (or transaction in a series) as designated by the Minister of National Revenue.

The draft legislation does not include any designated transaction. However, Finance has provided examples of transactions that may be notifiable transactions. These include transactions to avoid CCPC status, trust transactions to avoid the 21-year deemed realization rule, and back-to-back lending transactions to avoid the thin capitalization rules.

Uncertain Tax Treatments

The draft legislation provides that information for uncertain tax treatments is reportable on or before a corporation’s filing due date for the particular year. As drafted, a reportable uncertain tax treatment arises where the corporation’s relevant financial statements reflect uncertainty over whether a tax treatment will be accepted by the tax authority, including a decision not to include the particular amount in its income tax return.

Reassessment Period and Penalties

The Mandatory Disclosure Rules would extend the commencement of the normal reassessment period for an applicable transaction until the required disclosure has been made. Additionally, under the draft legislation, penalties are imposed for failure to report on a sliding scale up to a maximum of 25% of the tax benefit for reportable and notifiable transactions, and up to a maximum of $100,000 for each particular uncertain tax treatment.

Timing Considerations

As noted above, Finance has delayed the coming into force of changes to the rules for reportable transactions and the enactment of the rules for notifiable transactions. Thus, for 2023, taxpayers entering into reportable transactions that fall under the proposed rules (but not under the existing rules)[2] or notifiable transactions falling under the proposed rules should be aware of the disclosure obligations as currently drafted, but they will not yet have to disclose such transactions. Disclosure will be required after a bill implementing the Mandatory Disclosure Rules receives Royal Assent. This will give Finance time to assess the public’s feedback on the proposed rules and revise the draft legislation as it considers appropriate prior to taxpayers making the required disclosure. However, it is unclear whether this is equally applicable to uncertain tax treatments. 

For uncertain tax treatments, Finance maintained that the coming into force is applicable to taxation years beginning after 2022 (except for associated penalties which will apply only after Royal Assent). Thus, for 2023, most corporations to whom the uncertain tax treatment provisions may apply, will not have to begin to disclose the required information until 2024. However, relevant corporate taxpayers need to be cautious of triggering a deemed year-end and having the disclosure obligations for uncertain tax treatments arise while the legislation is in draft and being further considered by Finance. For example, if a relevant corporation ordinarily has a calendar year-end and concludes a transaction that causes a deemed year-end in March of 2023, it may have a disclosure obligation for reportable uncertain tax treatments in September of 2023. In this situation, it is unclear whether Finance will have sufficient time to assess the feedback received and revise the draft legislation (if it considers it appropriate to do so) prior to the required disclosure due date. Accordingly, corporations to whom the uncertain tax treatment rules could apply should carefully consider their disclosure obligations and associated timing prior to entering into transactions that cause a deemed year-end in 2023.

 

Authors: Lisa Watzinger, Senior Associate, KPMG Law LLP, and Emily Zhong, Associate, KPMG Law LLP