Section 237.3

Advisors may not have exposure to the reporting triggers (pp. 6-7)

• The proposals should take into account that some of the advisors involved in reportable or notifiable transaction may not be aware of the aspects of the planning giving rise to a reporting obligation, or whether the transactions end up being implemented, or their part in the transactions may be routine.

Note that in some cases a counterparty could be considered an "advisor" or "promoter". This could be the case if a counterparty participates in structuring a transaction, or even if the counterparty merely provides assistance in implementing a transaction. If so, confidentiality provisions in agreements between counterparties could satisfy the confidentiality hallmark and contractual representations and indemnities as to taxes could satisfy the contractual protection hallmark.

Expansion of “avoidance transaction” (pp. 8-10)

• The change of the “avoidance transaction” test to refer to “one of the main purposes” of the transaction or series (rather than using a “primarily” test for a transaction) means that, for example, having a small safe income dividend (representing an acceptable tax benefit) as part of a series would render all transactions in the series avoidance transactions – so that the presence of only one hallmark would engage a reporting requirement. An element of materiality should be added.

Narrowness of carve-outs (p. 2)

• Although the “contractual protection” (CP) definition has helpful carve-outs, various common arm’s-length commercial transactions, e.g., financing arrangements are not carved out and must instead be analyzed under the general framework of the reportable transaction (RT) rules.

Requirement that CP be “in respect of” an avoidance transaction (pp. 2-3)

• The CP must be “in respect of” an avoidance transaction.
• The CRA guidance indicates that establishing an RRSP is not a reportable transaction, even where the RRSP trustee is entitled to an indemnity that might be CP, stating that such an indemnity is not CP “in respect of” the avoidance transaction (establishing the RRSP) as it is a “form of protection that applies in the normal commercial or investment context” (an explanation drawing on a carve-out from the CP definition that was included in the August 2022 draft, then dropped.)
• A further rationale for the CRA position in this RRSP example “is that the trustee’s indemnity relates to transactions (for example, the making of non-qualified investments) that do not form part of the tax motivation that gives rise to the avoidance transaction.”
• This RRSP example highlights that the mere presence of CP is not sufficient to engage the CP hallmark and that a “discernible link must exist between the CP and the avoidance transaction in question.”
• To apply this same approach in the context, for example, of a cross-border loan transaction with an gross-up clause, where the loan itself was not an avoidance transaction but was part of a series of transactions that included an avoidance transaction (e.g., a rollover transaction), an entirely appropriate conclusion would be that the usual indemnity and gross-up are not CP “in respect of” that avoidance transaction, because the non-imposition of withholding tax on the loan is not one of the main purposes of the series.

“Tax Benefit” as a possible gatekeeper (pp. 3-4)

• CP is defined in relation to a “tax benefit,” which, in turn, refers to a reduction, avoidance, or deferral of amounts payable under the ITA.
• In the context of the above financing example, because interest to an arm’s-length foreign lender generally is not taxable under the ITA, there is no identifiable “reduction, avoidance or deferral” that would make the existence of a tax benefit clear.
• A tax benefit may also be identified by referring to an alternative transaction that might reasonably have been carried out but for the existence of the tax benefit (see Copthorne) - yet, in normal cross-border lending situations, no such reasonable alternative is likely to exist.
• Accordingly, the absence of a tax benefit is a further potential basis for a standard gross-up and indemnity in an arm’s-length lending transaction not engaging the CP hallmark.

“Opt Out or Contend with Uncertainty” (p. 5)

[P]arties can easily avoid the RT [mandatory reportable transaction] regime by modifying their practices. If a transaction exhibits no hallmark (contingent fees, confidentiality, or CP [contractual protection]), the RT regime is not engaged. …

It seems unlikely to us that parties will inadvertently fall into the RT regime. … Thus, only those who choose to undertake (or be implicated in) avoidance transactions linked to a potential hallmark must contend with any remaining uncertainty. …

“The Essence of a Hallmark” (p. 5)

Hallmarks are intended to identify potentially abusive transactions on the basis that such transactions often exhibit a hallmark. …

[H]allmarks do not just exist in the ether; rather, they reveal themselves in circumstances where their presence may influence or cause a party to engage in the targeted riskier behaviour by entering into the potentially aggressive transaction.

“Defining the CP Hallmark” (pp. 5-6)

• Given that that the CP hallmark must be present by the time the avoidance transaction was completed, “[p]rotection arising after the relevant avoidance transaction is consummated—and operating for the benefit of an arm’s-length person not involved with or interested in the earlier transaction that gave rise to the tax risk—is not the target.”
• Thus, the Explanatory Notes “differentiate, appropriately, between (1) a situation where a purchaser obtains protection from pre-sale liabilities (including tax) and (2) a situation where insurance is obtained to cover specific identified tax risks in relation to avoidance transactions.”
• Similarly, the CRA guidance indicates that protection relating to existing pre-closing tax issues, the quantum of existing tax attributes, and pre-sale safe income dividend transactions, do not bear the CP hallmark.
• However, the CP hallmark would apply if CP were received after the fact, but the taxpayer seeking the benefit knew in advance that this would occur, or if the purchaser and vendor agreed to reduce the risk of a contemporaneous avoidance transaction under the guise of standard indemnities.

No de minimis safe harbor (pp. 5-6)

• Consistent with the OECD approach, there should be a de minimis test or other filter to reduce the potential administrative burden to CRA and taxpayers.

Potential overlap between reportable and notifiable transactions (p. 8)

• Thetr is potential overlap, i.e., that a transaction could both be substantially similar to a notifiable transaction, and also have a hallmark apply so as to engage the reportable transaction rules.

In certain sectors of financial services, e.g., asset management or securities distribution, volume-based compensation for services is the norm. We note that the legislation does not refer to the number or value of securities that may be sold, nor does it refer to a fee based on net asset value or a similar concept. We understand that standard asset management and securities distribution fees are not intended to trigger this hallmark or to be subject to penalty.

If the undertakings by a fund manager extend to assisting in the resolution of tax disputes, this may trigger the contractual protection hallmark. We understand that the normal commercial practice of issuers and securities dealers distributing securities into the U.S. private placement market under a 144A offering would be to obtain deemed undertakings in the offering memorandum from prospective investors who are qualified institutional buyers, not to further disclose the offering memorandum, in order to ensure compliance with U.S. securities laws. Where the offering memorandum describes the details or structure of the transaction or series giving rise to a tax benefit, it is important that restrictions not extend to disclosure of the details or structure of the transaction or series.

The Federation of Law Societies of Canada has filed a petition in the B.C. Supreme Court seeking inter alia declarations that ITA ss. 237.3 and 237.4 “are inconsistent with the Constitution of Canada, and of no force or effect, to the extent that those sections apply to legal professionals” and “that the term ‘advisor’ as it is used in sections 237.3 and 237.4 …be read down so as to exclude legal professionals.”

In its accompanying Press Release, the Federation stated:

Requiring legal counsel to report to a government agency on their clients’ activities causes an irreconcilable conflict with the legal and ethical duties lawyers and other legal professionals owe to their clients. Backed by penalties that include large fines and the possibility of imprisonment for noncompliance, the legislation forces legal counsel to choose between their own interests and those of their clients. This conflict undermines the duty of commitment to the client’s cause, a duty found … in the Federation’s [money-laundering] 2015 case [2015 SCC 7] to be a principle of fundamental justice. As a result, the legislation violates section 7 of the Charter. The obligation for legal counsel to report confidential information to the CRA also violates the protection from unreasonable search and seizure in section 8 of the Charter.

… The Government of Canada has consented to a 30-day injunction suspending application of the provisions to members of the legal profession, pending a hearing on the Federation’s injunction application.