7 March 2019 CTF Seminar - Brian Ernewein on GAAR
This summarizes answers to some of the questions posed to Brian Ernewein (General Director, Legislation, Tax Policy Branch, Department of Finance) at a seminar of the Canadian Tax Foundation held in Toronto on 7 March 2019 in a segment entitled "How the Government has Dealt with the GAAR.” The moderator was Wayne Adams (CTF) and the other presenters were Natalie Goulard (Justice) and Suzanne Saydeh (CRA).
This summarizes remarks made by Brian Ernewein (General Director, Legislation, Tax Policy Branch , Department of Finance) at a seminar of the Canadian Tax Foundation held in Toronto on 7 March 2019 in a segment entitled "How the Government has Dealt with the GAAR.” The moderator was Wayne Adams (CTF) and the other presenters were Natalie Goulard (Justice) and Suzanne Saydeh (CRA).
Q.1 Finance's Role on GAAR Committee
Question: What is Finance’s role on the GAAR Committee?
Three reasons for Finance's participation
Ernewein: Finance, Justice, and CRA are not very compartmentalized when it comes to the GAAR Committee. All three Departments/Agencies are involved. We all step on each other’s toes, in the sense that all of us feel quite free to offer our views to each other. We are all comfortable offering views on how a transaction works on a technical interpretation of the Act, what the policy should be, or what the litigation strategy should be. It is very collegial, and we discuss all aspects of the transactions under review.
There are three main reasons why Finance participates. First, going back to GAAR’s introduction, there was a desire by the taxpayer and tax advisor stakeholders to have some check on the application and use of GAAR. One of the reasons for bringing GAAR matters up to Head Office for review was so that Finance and Justice could play a role, and I believe that is the case.
Second, the existence of the GAAR Committee and Finance’s participation in it is worthwhile from a risk-management perspective. The Committee is not the only window Finance has on CRA’s application of the tax system on the ground. There are other formal committees, such as the Adverse Decision Committee, and the Risk Management Committee more generally. CRA also puts together its own list of budget items every year including the so-called “integrity items,” so that we do have other means for getting this information, as well as the day-to-day exchanges of information at various levels. That said, the GAAR Committee often deals with novel/leading-edge transactions, and that helps Finance to get a window on what is happening and where action may be required.
The primary reason, though, is that Finance can assist the GAAR Committee by offering insights on the policy underlying the Act. This of course bears on the question of the scheme of the Act, which is relevant in assessing whether the transaction constitutes a misuse or abuse of the Act’s provisions.
Scheme of Act is determined objectively
I should emphasize that Finance does not bring “inside information” to this question. In a self-assessment system, the taxpayer is expected to determine their tax liability under the law. Even when it comes to the GAAR, it should be applied to the scheme of the law, as evidenced in the public record.
Hopefully, we offer experience and expertise to provide policy input into these questions. However, I do not think that what we do is something that taxpayers and their advisors should not be able to do themselves.
When s. 245 might not be applied to abuse of Act's scheme
A caveat is that there are very rare circumstances where we reach a conclusion that there is a misuse or abuse of the policy but recommend that GAAR not be applied. I will provide examples on the silly end of the spectrum so that you do not make too much of them.
For example, Finance might be releasing a Budget next week that obviates the policy concern. That may suggest that the case is one that there is no need to take on.
Another example might be where it appears that the scheme of a provision was not completely adhered to, and we would form a view that the policy is being violated. To construct a silly example, imagine that a loss entity, with many years of losses, foregoes its capital cost allowance deduction for the year so as not to make its losses larger. Somebody might look at that and suggest “well, that seems to be effectively extending the loss-carryover rules.” If that situation were to come up (and I don’t recall that it has) we might conclude that, even though someone might suggest that the very fact that we drafted specific limitations on loss carryforwards and this was a way of extending the carry-forward of losses, this might not be an occasion justifying using our resources to challenge taxpayers.
Q.2 The Effectiveness of GAAR
Question: What are your thoughts and observations on the effect GAAR has had?
Background to GAAR introduction
Ernewein: I think the best way to answer this question is to look back to GAAR’s inception and compare the circumstances then to now.
I started at Finance in mid-1985. The environment then was rather tough. I don’t think we felt that we were under siege, but it felt like we were losing ground. I remember, right after I started, Tim Morris, from the Tax Policy Branch, saying that he spent the entire weekend trying to convince CRA not to consider itself bound by a mandate to rule on every transaction that was technically legally effective, even if it had no business purpose or raised policy concerns. This was also in the aftermath of the Perrin Beatty task-force, which had chastised Revenue Canada for its conduct and led to CRA adopting this more literalist view.
We also had what most would concede were ineffective anti-avoidance rules in the legislation, and a rejection of the business-purpose test by the Supreme Court of Canada in Stubart. We also had a substantial loss-overhang and a deficit.
The consequence of all these things was that there was a tremendous amount of energy expended in trying to swat away issue after issue. Because of the loss-overhang, after-tax financing presented a real opportunity that the banks started developing. From 1978 on, this lead to all sorts of preferred share rules – the term preferred share rules, the guaranteed and short-term preferred share rules, collateralized preferred shared rules, leading all the way up through that decade, to the taxable preferred share rules in 1987. (I believe a raft of preferred share amendments were released on the June 18. 1987 (GAAR release) date.)
There were all kinds of other transactions as well – the carve-out arrangements in the mineral patch, the Genstar Trust arrangement, use of limited partnership losses, the Skytrain financing, Gulf Oil little-Egypt bump (my first file), provinces setting up taxable corporations to raise general corporate revenues (before the taxable preferred share rules came along, they would be able to issue these shares and pay lower dividends than they would interest rates, even though they were just going to use the money for general corporate revenues). We had undertaken a major reform of our corporate loss-transfer rules, and in January of 1987, we were looking at imposing a capital tax on banks to try to stanch the revenue flow.
There was this view that we were legislating by press-release – every fortnight, we were dealing with something else.
Decision to introduce GAAR
Thus, while we were not feeling under siege, I think there was a view that we should be doing something differently. We were in unsustainable deficits, and in the context of a decision to undertake fundamental tax reform, and also in the context of an international discussion about adopting a general anti-avoidance rule of that kind (others had done it or were considering doing it).
Given all that, I think the decision made then to pursue the development of a general anti-avoidance rule made complete sense. There were certainly detractors, who asserted that it breached the rule of law, or tax evasion or avoidance by people who couldn’t figure out what the law required them to do. The best argument that I recall was that we had already fixed everything so there was no point in having the GAAR (which was self-interested, to say the least). So, there certainly was justification in having the GAAR.
Thirty years later, do I think it was ultimately the right decision? I don’t think there is any way to prove the counterfactual. If we had not done it, perhaps the courts would have become more activist in challenging certain transactions, but in sum I think it seems like an improvement. Perhaps five years ago people would not have reached the same conclusion or reached it with less confidence. It has put a brake on some overly aggressive planning, without unduly impeding legitimate activity. I do think we have effectively engaged the Courts and CRA to give more than lip-service to something resembling a textual, contextual, and purposive analysis of legislation.
While we certainly haven’t closed our “loophole-closing shop,” I think we have had to spill a lot less ink dealing with avoidance transactions and structures than we would have had to in the absence of GAAR.
Q.3 Future of GAAR
Question: Any thoughts on what the future holds for GAAR?
Abusive transactions with a business purpose
Ernewein: There is one thing worth thinking about. If you were to explain GAAR to a precocious child, and said “if you do a bad thing, and don’t have a business purpose, then we take away the thing you want,” the child might then ask “so if I do have a business purpose, I can do bad things?” That doesn’t seem self-evident!
I think the answer to that is that GAAR is at the limit, it is a last resort. It is intended to apply only where there is both an absence of a primary business or other non-tax purpose and a “bad thing.” Arguably, where there are “bad things” but with a business purpose involved, that’s where we are expected to come in with standard legislation.
Potential statutory GAAR changes
The things that people talk about are also the things we discuss amongst ourselves – whether there should be the introduction of a GAAR penalty, whether doing that could have an adverse influence on the jurisprudence, i.e., whether even after 30 years the introduction of a GAAR penalty would have a deleterious effect on the jurisprudence thereby introducing a downside - and also, whether economic substance should be explicitly incorporated into GAAR, and (a question that I have) how that would plug into GAAR.
Reading the Wild case, it seems inconsistent with the expressed intention of Parliament – but I also appreciate the legislative concern that the decision identified. There’s a question for both CRA and taxpayers as to whether something should be done to put that area back to where we all thought it was.
I don’t know if I have heard others in government quarters discuss this, but something might be done to require more reporting of aggressive transactions - we have a knack for disclosure rules, but should something more be done?
I will add that we understand, and everyone else would agree, that any changes to GAAR should be made with extreme caution.
Q.4 Explanatory Note GAAR comments
Question from Audience: Finance sometimes still closes loopholes with specific anti-avoidance rules. Sometimes the Explanatory Notes will say that GAAR will still apply. How does Finance decide when to include commentary in the Explanatory Notes regarding the potential application of GAAR?
Ernewein: Essentially, it is informed by our discussions with CRA as to what the position is on a particular structure or type of transaction. If they are pursuing it under GAAR, we will say that we think GAAR can apply. If they think it might, then we might make that statement. If they conclude that it cannot, then we do not make a statement.