CRA Designates Notifiable Transactions and Updates Mandatory Disclosure Guidance

Table of Contents

• Introduction

• Notifiable Transactions

  • Background

  • Notifiable Transaction Reporting

• Updated CRA Guidance

  • Reportable Transactions

  • Contractual Protection

  • Contingent Fees

  • Confidential Protection

  • ​Uncertain Tax Treatments

Introduction

On November 1, 2023, the Canada Revenue Agency (CRA) released a list of transactions that have been designated as the first “notifiable transactions” under the new mandatory disclosure rules (MD Rules) in the Income Tax Act (Canada) ( ITA), which were enacted on June 22, 2023 (November 1 Release). For our bulletin discussing these rules, please see Blakes Bulletin: Mandatory Disclosure Update: Department of Finance Introduces Revised Rules in the House of Commons. The November 1 Release was posted on the CRA website without advance warning or any broader public announcement. This is troubling given the broad application of the reporting rules and the fact that the designation was made with immediate effect.

On November 2, 2023, the CRA released updated guidance on the application and administration of the MD Rules (Updated Guidance). For our July 2023 bulletin discussing the CRA’s original guidance on these rules, please see Blakes Bulletin: Canada Revenue Agency Publishes Guidance on Mandatory Disclosure Rules.

The Updated Guidance provides additional examples of situations where the CRA does not expect that reporting would be required. The majority of the changes in the Updated Guidance relate to the “reportable transaction” rules, though limited updates have also been made to the discussions of the “notifiable transaction” and “reportable uncertain tax treatment” rules. These changes are generally helpful and respond to some of the concerns raised by the tax community regarding the broad scope of the MD Rules.

Notifiable Transactions

Background

In February 2022, the Department of Finance released a backgrounder (2022 Backgrounder) and proposed legislation to implement mandatory disclosure measures originally announced in the 2021 Federal Budget. These proposals included a new reporting regime applicable to “notifiable transactions” — transactions that are “the same as, or substantially similar to,” specific designated transactions that have been identified by the CRA as potentially abusive or as transactions of interest (i.e., transactions that warrant further information to determine if they are abusive). The 2022 Backgrounder identified six sample categories of notifiable transactions.

The November 1 Release has retained five of the six categories of transactions that were identified in the 2022 Backgrounder. The final category of transactions included in the 2022 Backgrounder, which involved planning designed to manipulate “Canadian-controlled private corporation” status, was addressed by the proposed “substantive CCPC” rules included in the 2022 Federal Budget.

Notifiable Transaction Reporting

Under the notifiable transaction rules, the Minister of National Revenue, with the concurrence of the Minister of Finance, has the authority to designate from time to time, including through the CRA website, specific types of transactions or series of transactions that will require reporting. The Updated Guidance confirms more definitively that it is intended that the CRA website will be used to designate notifiable transactions, and that the effective date for new designations will be the date such transactions are posted on the website.

Since the initial release of the MD Rules in February 2022, stakeholders have expressed significant concerns about the way notifiable transactions are designated. The publication of designated transactions on the CRA’s website has been criticized for imposing an undue burden on taxpayers and advisors, requiring them to monitor the website daily to stay informed about new designations, particularly in light of the short 90-day reporting deadline. In response to these concerns, taxpayers and advisors can now subscribe on the CRA website to be notified by email when new transactions are designated as notifiable.

Reporting under the notifiable transaction rules is required with respect to designated transactions, transactions that are “substantially similar” to designated transactions, and any transaction in a series of transactions that is either the same as or substantially similar to a designated series of transactions.  A particular transaction is “substantially similar” to a designated transaction where the two transactions are expected to result in the same or similar tax consequences, and the two transactions are either factually similar or based on the same or similar tax strategy. There is no specific guidance on the determination of whether transactions are “factually similar” or what constitutes a “similar tax strategy” (both undefined concepts in the ITA). While the term “tax consequences” is defined in the ITA, it refers to amounts (e.g., the amount of taxable income) rather than the results of a particular transaction. It is not clear how this concept is intended to apply in this context. Notably, the rules expressly provide, as a legislated rule of interpretation, that the “substantially similar” test is intended to be interpreted broadly in favour of disclosure. This is a new and unusual interpretational concept in the ITA. The Updated Guidance confirms the broad interpretation of this test, stating that a transaction may be substantially similar to a notifiable transaction even though it involves different entities or uses different provisions of the ITA.  

The following persons are subject to reporting requirements in respect of a notifiable transaction:

1. Every person for whom a “tax benefit” (as defined for purposes of the general anti-avoidance rule in the ITA) results from the transaction;

2. Every person who enters into the transaction for the benefit of a person described in (a);

3. Every advisor or promoter in respect of the transaction; and

4. Every person not dealing at arm’s length with an advisor or promoter who is entitled to a fee in respect of the transaction.

Notably, in the notifiable transaction rules, the advisor reporting requirement is not limited to advisors who receive specified types of fees, as is the case in the reportable transaction rules. However, there is an exception for advisors who provide only clerical or secretarial services with respect to a transaction.

The Federation of Law Societies of Canada (Federation) has obtained a temporary injunction of the application of the advisor reporting rules to lawyers and certain other legal professionals, pending the outcome of its application for an injunction. The hearing for the application was held on October 20, 2023. The temporary injunction will apply until the earlier of December 1, 2023, and the date on which the court releases its decision in response to the application. The injunction relates to the challenge brought by the Federation as to the constitutionality of the MD Rules as applied to legal professionals.

A due diligence defence from reporting under the notifiable transaction rules is available to taxpayers who have exercised appropriate care, diligence and skill in determining that a transaction is not notifiable. The technical notes to the rules specifically provide that this defence may be satisfied where a taxpayer obtains advice that the notifiable transaction rules do not apply. A separate due diligence defence is available to advisors and promoters who should not reasonably be expected to know that a transaction was a notifiable transaction.

The reporting deadline for notifiable transactions is 90 days after the earlier of the date on which a taxpayer becomes contractually obliged to enter into the transaction and the date on which the taxpayer enters the transaction. The Updated Guidance confirms that such 90-day window cannot begin before a transaction has been designated as a notifiable transaction, but that reporting obligations will apply to transactions that “straddle” the effective date of designation. This means that reporting will be required in respect of a notifiable transaction where the taxpayer contracted to enter into the transaction prior to the effective date of designation but did not enter the transaction until after that date. Further, reporting will be required in respect of a series of transactions that straddles the effective date of designation (i.e., where some transactions in the series were entered into on or before the effective date of designation and other transactions were entered into after that date). In these cases, the reporting deadline will be 90 days after the first relevant transaction that occurs after the designation date.

Certain of the designated transactions highlight a significant concern about the 90-day reporting window when applied to a series of transactions. While a preliminary transaction may form part of a series of transactions, a taxpayer or advisor may not know until many years in the future whether a notifiable transaction has occurred. The rules are unclear as to whether there would be an obligation to report before the series is complete. In many cases, the due diligence defence should presumably apply to protect from reporting obligations before it can be known based on steps already completed that a transaction will be notifiable.

The transactions that have been designated as notifiable transactions as of November 1, 2023 are summarized below. Importantly, some of these designations target broad categories of transactions (such as back-to-back arrangements), rather than any precise transactions. The vague nature of these categorical designations adds uncertainty and complexity to the determination of whether a given transaction is (or is substantially similar to) a designated transaction and, therefore, subject to reporting. It is unclear whether the CRA intends to provide further guidance as to the interpretation of the designated transaction types and the “substantially similar” requirement, though such guidance would be very helpful.

1. Straddle Loss Creation Transactions Using a Partnership

The most basic type of “straddle transaction” occurs when a taxpayer simultaneously enters into two equal and offsetting financial instrument positions but settles the “loss” leg at the end of the taxation year when the transactions were entered into and settles the offsetting “gain” leg at the beginning of the following taxation year. The loss in the first taxation year enables the taxpayer to reduce its income in the first taxation year, while the offsetting gain is deferred until the succeeding taxation year. Deferral can be extended by entering into successive straddle transactions in future taxation years.

The 2017 Federal Budget introduced anti-avoidance rules (Straddle Rules), which are designed to delay deductions resulting from straddle transactions until such time as the offsetting gains are realized, thus neutralizing the potential for deferral. However, the November 1 Release indicates that some taxpayers have sought to avoid the Straddle Rules by using partnerships. Accordingly, the following series of transactions has been designated as a notifiable transaction:

• A taxpayer enters into an agreement to acquire a partnership interest from an existing partner.

• The partnership trades foreign exchange forward purchase and sale agreements on margin through a foreign exchange trading account. The foreign exchange forward agreements are essentially straddle transactions where it is reasonable to conclude that each agreement is held in connection with the other and where, in the aggregate, the individual agreements (legs) will generate substantially equal and offsetting gains and losses. 

• Shortly before the taxpayer’s acquisition of the interest in the partnership, the partnership disposes of the gain leg(s) of the foreign exchange forward agreement(s). 

• The income from the gain leg(s) is then reflected in the income of the partnership and is allocated to the original partner immediately prior to the acquisition of the interest in the partnership by the taxpayer.

• Following the acquisition of the partnership interest by the taxpayer, the loss leg(s) are realized and a business loss is allocated to the taxpayer.

2. Avoidance of Deemed Disposal of Trust Property
 

Subsection 104(4) of the ITA, known colloquially as the “21-year rule,” generally deems certain trusts to have disposed of and reacquired certain property at fair market value every 21 years. The 21-year rule can be avoided if the trust distributes or otherwise transfers its property prior to the deemed disposition date. The ITA permits such a transfer to occur on a rollover basis in some circumstances, but generally does not permit distributions or transfers to non-resident beneficiaries or to other trusts on a non-taxable or tax-deferred basis. The November 1 Release indicates that some taxpayers are engaging in transactions that seek to avoid these restrictions. (Indeed, transactions similar to those designated have been the subject of CRA commentary in the past, including at the 2017 APFF Conference.) The following three series of transactions have been designated as notifiable transactions:

Indirect Transfer of Trust Property to Another Trust

• A Canadian resident trust (New Trust) holds shares of a corporation resident in Canada (Holdco) that is or will become a beneficiary of another Canadian resident trust (Old Trust) that holds property that is capital property or land included in the inventory of a business of Old Trust. At any time prior to its 21-year anniversary, Old Trust transfers the property to Holdco on a tax-deferred basis pursuant to subsection 107(2) of the ITA.

Indirect Transfer of Trust Property to a Non-Resident

• One or more of the non-resident beneficiaries of a Canadian resident trust hold shares of a corporation resident in Canada (Holdco) that is or will become a beneficiary of the trust. At any time prior to its 21-year anniversary, the trust transfers certain property to Holdco on a tax-deferred basis pursuant to subsection 107(2) of the ITA.

Transfer of Trust Value Using a Dividend

• A Canadian resident trust (New Trust) holds shares of a corporation (Holdco) that is or will become a beneficiary of another Canadian resident trust (Old Trust) that holds property that is shares in a Canadian corporation (Opco). At any time prior to Old Trust’s 21-year anniversary, Opco redeems shares held by Old Trust and issues a promissory note or gives cash as consideration, which means that Opco is deemed pursuant to subsection 84(3) to have paid, and Old Trust is deemed to have received, a dividend equal to the amount by which the amount paid by Opco on the redemption exceeds the paid-up capital in respect of the shares. The deemed dividend is designated by Old Trust and deemed to be received by Holdco pursuant to subsection 104(19), which dividend is deductible in the hands of Holdco pursuant to subsection 112(1). The cash or the promissory note is paid or made payable in the year by Old Trust to Holdco as payment for the dividend allocated to it.

3. Manipulation of Bankrupt Status to Reduce a Forgiven Amount in Respect of a Commercial Obligation

The ITA includes so-called “debt forgiveness” rules which apply where certain debts and preferred shares (defined collectively as “commercial obligations” in the ITA) are settled and there is a “forgiven amount” in respect of the obligation. Very generally, where the debt forgiveness rules apply, the forgiven amount is applied to reduce the debtor’s unused loss carryforwards, undepreciated capital cost and other tax attributes. When the debtor’s relevant tax attributes are exhausted, a portion (generally 50%) of the remaining forgiven amount is included in the debtor’s income, subject to the debtor and a related person filing an election to transfer the forgiven amount to the related person. 

These rules do not apply to a settlement of a commercial obligation that occurs while the debtor is bankrupt because in such circumstances the “forgiven amount” calculates to nil.

The November 1 Release states that some taxpayers are entering into arrangements in which they are temporarily assigned into bankruptcy prior to settling or extinguishing commercial obligations in order to reduce the forgiven amount in respect of such commercial obligations to nil. The bankruptcy is subsequently annulled but the taxpayer has avoided the application of the debt forgiveness rules such that it suffers no reduction in tax attributes and has no income inclusion.

Accordingly, the following series of transactions has been designated as a notifiable transaction:

1. A debtor (which can be a person or partnership) is assigned into bankruptcy.

2. While the debtor is a bankrupt, a commercial obligation of the debtor is settled, deemed to be settled or extinguished for an amount that is less than the principal amount of the obligations.

3. At any point in time, the debtor files a proposal under Part III of the Bankruptcy and Insolvency Act and the bankruptcy is annulled by a court. 

4. Reliance on Purpose Tests in Section 256.1 to Avoid a Deemed Acquisition of Control

Section 256.1 of the ITA is an anti-avoidance rule that targets certain corporate attribute trading transactions. The primary rule, referred to below as the “75% rule,” applies where a person acquires more than a 75% interest in a target corporation by fair market value without acquiring control of the corporation. Absent section 256.1, such transactions generally would not engage the attribute trading restrictions in the ITA, which apply where a corporation is subject to an acquisition of control.

Section 256.1 contains three “purpose tests”:

1. The “75% rule” will only apply if it is reasonable to conclude that one of the main reasons there was not an acquisition of control of the target corporation was to avoid the application of one or more of the attribute trading restrictions in the ITA. 

2. There is also a companion “disregarded transaction rule” that disregards any particular transaction or event for purposes of the 75% rule if it is reasonable to conclude that one of the reasons for that transaction or event is to avoid the 75% threshold being surpassed.

3. Section 256.1 also includes a separate “deemed acquisition of control rule” that deems a particular corporation to be subject to an acquisition of control if, as part of a transaction or series, there is an acquisition of control of another corporation and it can reasonably be concluded that one of the main reasons for the transaction or series is to avoid the application of an attribute trading restriction to the particular corporation. This latter rule targets situations where, for example, a “loss corporation” (i.e., a corporation with undeducted losses or other tax attributes) acquires control of an unrelated profitable corporation in order to avoid the application of loss-trading restrictions that would apply if the profitable corporation had acquired control of the loss corporation.

The November 1 Release designates as notifiable transactions the following series of transactions involving a taxable Canadian corporation with relevant tax attributes (referred to below as a “Lossco”) in which taxpayers rely on one of the purpose tests described above to conclude that the attribute trading restrictions in section 256.1 do not apply. It should be noted that the relevant tax attributes for purposes of these rules are not limited to loss carryforwards; they also include undepreciated capital cost of depreciable assets, undeducted scientific research and development expenses, investment tax credits and certain resource expense pools.

• Lossco is the subject of a transaction resulting in a person’s interest in Lossco exceeding the 75% threshold, but that does not result in an acquisition of control of Lossco. The taxpayer takes the position that the purpose test in the attribute trading restriction rule does not apply.

• Lossco is the subject of a transaction in which a corporation (Profitco) and a person not dealing at arm’s length with Profitco (Aco) acquire shares of Lossco. The transaction does not give rise to an acquisition of control of Lossco and Profitco’s acquired interest in Lossco does not exceed the 75% threshold, but would have if the acquisition of shares of Lossco by Aco were ignored. The taxpayers take the position that the purpose test for the disregarded transaction rule is not satisfied.

• Lossco acquires control of another corporation and it can reasonably be considered that one of the reasons for the acquisition is so that none of the attribute trading restriction rules in the ITA applies. The taxpayers take the position that the purpose test in the deemed acquisition of control rule is not satisfied.

The designation of transactions which require reporting where a taxpayer relies on a purpose test clearly captures purely commercial transactions. Having regard to the breadth of the reporting requirements in the rules (including the inclusion of “substantially similar” transactions, each as discussed above), this category of notifiable transactions may engage a broad range of commonplace commercial transactions simply because one or more of the corporations involved has relevant tax attributes, even where the transactions have no tax motivation. The scope of this reporting seems unnecessarily broad.

The November 1 Release provides only that these designated transactions “are aimed at identifying situations where taxpayers rely on one of the purpose tests to conclude that the 75% rule or the deemed acquisition of control rule does not apply to transactions or events that would otherwise have satisfied all of the other conditions enumerated within those provisions.” Further guidance from the CRA as to the intended scope of this category of notifiable transactions would be welcome.

5. Back-to-Back Arrangements

The ITA’s thin capitalization regime and its withholding tax regime contain rules governing back-to-back arrangements.

The thin capitalization regime denies the deductibility of certain interest paid to specified non-residents if the taxpayer is offside a debt-to-equity ratio of 1.5 to 1, computed in accordance with rules specified in the ITA. The back-to-back rules expand the ambit of those rules to apply to interest paid to persons other than specified non-residents where, very generally, interest is paid to an intermediary and the intermediary has entered into certain connected funding arrangements with a specified non-resident. The back-to-back rules are intended to capture situations where a taxpayer is indirectly paying interest to a specified non-resident but without the thin capitalization regime otherwise applying.

The withholding tax regime imposes tax on certain payments made by residents of Canada to non-residents. In the context of interest, whether withholding tax applies can depend on whether the recipient deals at arm’s length with the payor. In addition, for interest paid to non-arm’s length persons, the amount of withholding may be reduced under a relevant tax treaty, depending on the jurisdiction in which the recipient is resident and whether such recipient is entitled to such treaty benefits. The ITA also imposes withholding tax on certain rents, royalties and similar payments, which may also be reduced under an applicable treaty.

The back-to-back rules in the withholding tax regime are detailed and highly complex, but the basic intent is to ensure that taxpayers cannot reduce or eliminate withholding tax by indirectly paying an amount to a particular non-resident through one or more intermediaries. A simple example is a situation where a Canadian taxpayer pays interest to an arm’s length non-resident intermediary and that intermediary in turn pays interest to another non-resident who does not deal at arm’s length with the Canadian payor. A payment of interest directly to the non-arm’s length non-resident would have attracted withholding tax but, absent the back-to-back rules, the payment of interest to the intermediary would not. The back-to-back rules for withholding tax include “character substitution” rules designed to ensure that the rules can apply to arrangements involving payments with varying legal character.

The November 1 Release designates as notifiable transactions the following transactions:

• Thin capitalization: A specified non-resident enters into an arrangement with an arm’s length non-resident to indirectly provide financing to a Canadian taxpayer. The taxpayer files or anticipates filing its income tax returns on the basis that the interest paid on the debt or other obligation owing by it is not subject to the thin capitalization rules.

• Withholding tax: A non-resident (NR1) enters into an arrangement to indirectly provide financing to a Canadian taxpayer through another non-resident (NR2). If interest had been paid by the Canadian directly to NR1, it would be subject to Part XIII tax but the Canadian taxpayer’s income tax reporting reflects, or is expected to reflect, that the interest it pays in respect of the arrangement is either not subject to withholding tax or is subject to a lower rate of withholding tax than the rate that would apply on interest paid directly by it to NR1. Alternatively, similar arrangements are entered into in respect of rents, royalties or other payments of a similar nature, or to effect a substitution of the character of the payments.

Of all the designated transactions, the back-to-back arrangements are the most open ended. Indeed, that appears to be precisely the intent. That said, it is interesting that the nearly identical back-to-back rules with respect to shareholder loans are not included in the designation.

The November 1 Release provides the following rationale for designating the above back-to-back arrangements as notifiable transactions: “The Canada Revenue Agency and the Department of Finance consider the following transactions and series of transactions to have the potential for tax avoidance or evasion, but they lack sufficient information to make that determination.” Although not explicitly stated, this suggests that the government has some suspicion that tax avoidance is occurring but does not have information about the specific transactions being implemented.

In this aspect, the designated back-to-back transactions are very different from the designated “purpose test” transactions discussed above. Whereas the designated purpose test transactions suggest that the CRA intends to audit scenarios where taxpayers rely on the purpose test to determine whether it agrees that the purpose test was satisfied, the designated back-to-back arrangements appear to capture broader sets of circumstances that contain some of the elements of a back-to-back arrangement, but where it has been determined that the back-to-back rules do not apply for any reason. The specific factual elements of a transaction or series that would bring it within the scope of the designation are not described in the designation, which will undoubtedly leave many taxpayers and advisors in an uncertain position as to whether a particular transaction is notifiable.

While there is nothing objectionable about the government seeking information about tax planning strategies, it is questionable whether designating a vague concept rather than a specific transaction or series of transactions pursuant to the notifiable transaction rules is the appropriate approach to information gathering, particularly having regard to the short timeframe for reporting. Persons who fail to report, even inadvertently, can face significant penalties. Given the difficulty in determining whether a transaction is of the type designated, let alone substantially similar thereto, and the high likelihood that many of the transactions captured by this category of designated transaction will be mundane and inoffensive, the consequences to those who fail to report seem unduly harsh.

Clearer language that more specifically delineates those transactions that are designated in connection with the back-to-back rules is certainly desirable. Failing that, it is to be hoped that future updates to the CRA guidance on the MD Rules can offer some clarification, including specific examples of transactions that do not require reporting.

Updated CRA Guidance

Reportable Transactions

The Updated Guidance includes a number of helpful new examples of scenarios where the CRA will not require reporting under the reportable transaction rules. Many of the new examples appear to be responsive to specific submissions that have been made with respect to the possible overbreadth of the reportable transaction hallmarks in the legislation. In particular, in response to concerns raised by the tax community, the Updated Guidance describes a number of relatively common commercial arrangements and transactions for which reporting will not be required. The CRA’s focus on such common arrangements and transactions is a welcome development.

Importantly, the Updated Guidance clarifies that the lists of situations where reporting is not required under the various hallmarks are not meant to be exhaustive, which should be helpful to avoid taxpayers and advisors drawing adverse conclusions from the fact that certain situations have not been addressed in the CRA guidance.

Contractual Protection

The Updated Guidance indicates that reporting will not be required under the reportable transaction rules merely as a consequence of the following:

1. Standard commercial indemnity provisions in commercial agreements and client documentation which do not contemplate a specified identified tax benefit or treatment. This expands upon the original guidance, which only provided comfort with respect to standard representations, warranties and guarantees in the M&A context.

2. Standard contractual representations and indemnities with respect to the failure to deduct or withhold tax under Part XIII of the ITA from arm’s length payments to non-residents.

3. Tax return insurance obtained by taxpayers provided the following three requirements are satisfied: (i) the insurance extends to a taxpayer’s filings generally (as opposed to any particular filing), (ii) the insurance does not contemplate any particular transaction or series entered into by a taxpayer, and (iii) those who engage in aggressive tax planning would continue to bear potentially significant financial risks associated with aggressive tax planning activities. The Updated Guidance explains that in this context the insurance would not pay for or reimburse taxpayers for tax imposed as a result of disputed tax positions in respect of aggressive tax planning, and is subject to a maximum amount of coverage (or protection) which would not likely cover a material portion of the total expenses incurred by a taxpayer as a result of an audit in respect of aggressive tax planning. This exception is welcome relief to the tax return insurance industry.  

4. The reinsurance of risks covered by an original insurance policy where the original policy did not give rise to a reporting obligation.

5. Standard clauses in partnership agreements where the partnership agrees to provide reasonable assistance to partners to help resolve audits, provided the purpose of the clause does not contemplate any particular avoidance transaction or series.

6. Indemnification for terminating trustees in connection with mutual fund mergers.

7. Commercial price adjustment clauses (such as working capital adjustments).
   
   The Updated Guidance also provides more generally that the contractual protection hallmark will not apply in a “normal commercial or investment context in which parties deal with each other at arm’s length and act prudently, knowledgeably and willingly, and does not extend contractual protection for a tax treatment in respect of an avoidance transaction.” This language was previously proposed to be an exclusion from the definition of a “reportable transaction” in the statute but was subsequently removed and replaced by the more context-specific exception in the M&A Carve-Out discussed below. It appears that the CRA has chosen to restore this language administratively, even though it was not enacted by Parliament. The Updated Guidance includes the following examples of the intended scope of this exception (which is also stated to be the basis of the exception for RRSP trustee indemnities included in the original guidance):

• Tax indemnities in standard provisions, such as gross-up clauses in loan agreements or International Swap and Derivative Agreements (ISDAs); and

• Tax indemnities in employment agreements and severance agreements.

The original guidance also contained several examples of contractual protection that is integral to an arm’s length sale of a business and therefore, in the CRA’s view, is generally excluded from the contractual protection hallmark (M&A Carve-Out). The Updated Guidance adds a number of new scenarios in which the CRA indicates that the M&A Carve-Out should apply:

• The Updated Guidance extends to the private company context the statement in the original guidance that specific contractual covenants and indemnities obtained by a public company purchaser in an acquisition, which are intended to give the purchaser protection in respect of the availability of the paragraph 88(1)(d) basis “bump,” fall under the M&A Carve-Out.

• The Updated Guidance includes a new example of the M&A Carve-Out applicable to indemnities or covenants to a purchaser and/or target in respect of adverse tax consequences arising from dividends paid (e.g., an excessive capital dividend election) as part of a pre-closing reorganization.

• The Updated Guidance confirms that the previously announced exception for tax insurance in respect of dispositions of “taxable Canadian property” applies to all forms of protection, such as seller indemnities.

• The Updated Guidance clarifies that tax insurance or other contractual protection for specifically identified tax risks in relation to an avoidance transaction may benefit from the M&A Carve-Out, but only to the extent that the risks in question are among those listed in the guidance.

The Updated Guidance also helpfully confirms that the requirement under the M&A Carve-Out that protection be provided in connection with an arm’s length sale of a business will be interpreted to include various different ways in which a direct or indirect sale may be structured, including a partial sale of interests in a corporation, partnership or trust, a subscription by the purchaser and redemption of the sellers, or a merger or acquisition effected by the amalgamation of two arm’s length corporations.

Contingent Fees

The Updated Guidance extends the exclusion in the original guidance for contingent litigation fee arrangements in relation to tax appeals to professional assistance provided in connection with an audit or the issuance of assessments, including proposed reassessments (i.e., before the appeal stage). This is a welcome expansion of the original guidance, but it should be noted that this exception appears to still only apply to professionals who are engaged to provide audit or dispute assistance after completion of the relevant transaction. The related exclusion for such fee arrangements from the contractual protection hallmark is similarly extended.

Confidential Protection

The Updated Guidance provides that the following standard confidentiality arrangements do not give rise to a reporting requirement under the confidential protection hallmark:

• Standard confidentiality agreements that do not require tax advice to be confidential, such as a confidentiality provision in a letter of intent; and

• Standard commercial confidentiality provisions in standard client agreements or documentation which do not contemplate a specific identified tax benefit or treatment.

These exceptions address the concerns that very common, non-tax-specific, confidentiality requirements may result in reporting requirements.

Uncertain Tax Treatments

The Updated Guidance also provides the following clarifications with respect to the reportable uncertain tax treatment rules:

• Even where multiple entities in a consolidated group report uncertain tax positions on their consolidated financial statements, each reporting corporation is separately responsible for reporting its own uncertain tax treatments and not those of other related corporations.

• The uncertain tax treatment reporting obligations generally do not apply to portfolio investments in private equity limited partnerships or publicly traded partnerships. This is a necessary concession for portfolio investors, who typically would not have control over a fund’s operations or its reporting, and who may be unable to obtain the requisite information.

For more information, please contact any member of our Tax group.