Mandatory Disclosure Update: Department of Finance Introduces Revised Rules in the House of Commons

On April 17, 2023, the Department of Finance (Finance) released a Notice of Ways and Means Motion (NWMM) to implement certain proposals announced in the 2023 Federal Budget. The NWMM also includes much-awaited updated proposals (Proposals) for the mandatory disclosure rules initially released on February 4, 2022, and revised on August 9, 2022, together with revised explanatory notes (Explanatory Notes). See our Blakes Whitepaper: Department of Finance (Canada) Releases Significant Draft Tax Legislation for a summary of the original proposed mandatory disclosure rules.
 
The mandatory disclosure rules have been the subject of significant comment, criticism and concern, including about the breadth of both the transactions to which they apply and the categories of taxpayers, advisors and promoters proposed to be subject to reporting requirements.
 
The new Proposals include important changes to both the “reportable transaction” and “notifiable transaction” rules. The former require reporting for transactions that include one or more “hallmarks” of abusive tax planning. The latter require reporting for certain specific transactions that are designated by the Minister of National Revenue (Minister), with the concurrence of the Minister of Finance from time to time. (The new reporting rules for uncertain tax treatments announced in the February 2022 proposals are also included in the NWMM, but those proposals have not been changed.)
 
The Proposals address criticisms of the original proposals regarding certain standard fees and billing practices that are not intended to trigger the “contingent fees” hallmark, and standard protections in M&A transactions which are not intended to trigger the “contractual protection” hallmark under the reportable transaction rules. However, many other concerns — including the breadth of the “contractual protection” hallmark outside the M&A context — remain unresolved.
 
Under the Proposals, the revised reportable transaction and new notifiable transaction rules will apply to transactions entered into after the Proposals receive royal assent. However, unlike previous versions of the rules that were released for consultation, the new Proposals have been tabled in the House of Commons, and as of April 28, 2023, they have passed first reading. The new Proposals will likely be implemented in the near term and substantially in their current form. Taxpayers and advisors may only have limited time to put processes and systems in place to deal with these rules before they become effective.

REPORTABLE TRANSACTIONS

Hallmarks

A transaction will be a reportable transaction if it includes any one of the following three hallmarks:

1. An advisor or promoter has an entitlement to a “contingent fee” based on the amount of a tax benefit arising from the transaction, success in obtaining the tax benefit, or the number of persons who participate in the transaction;

2. An advisor or promoter obtains “confidential protection” in respect of the tax treatment of the transaction; and

3. The taxpayer or an advisor or promoter has or had “contractual protection,” providing protection from or assistance in defending against the failure of the transaction to achieve any tax benefit.

The breadth of the hallmarks and their potential application to a broad range of unremarkable commercial transactions has been a significant concern and the subject of many submissions to Finance since the original proposal to change the existing reporting requirement (which requires the presence of two hallmarks). While the Proposals do not include broad changes to the text of the hallmarks themselves (other than the context-specific narrowing of the contractual protection hallmark for certain M&A transactions as discussed below), the Explanatory Notes state that the expanded reporting obligations under the new rules should not result in an unnecessary compliance burden, and that normal commercial transactions that do not pose an increased risk of abuse are not meant to be caught.
 
The Explanatory Notes suggest that over time, the Canada Revenue Agency (CRA) will provide administrative guidance about its interpretation of the scope of the reporting requirements. This may be small comfort, however, to taxpayers and advisors who will very shortly need to grapple with these rules, as it is unclear when such guidance may be provided. 

Contingent Fees Hallmark

The Explanatory Notes provide new guidance on the types of fees that are intended to be captured by the contingent fees hallmark. The notes specifically indicate that the following types of fees are generally not expected to be captured:

• “value billing” by professionals such as lawyers and accountants in which a fee is agreed to based on value criteria, other than the value of tax benefits resulting from a transaction or series;

• contingent litigation fee arrangements in relation to tax appeals for already completed transactions where the litigator is not otherwise considered to be an “advisor” in respect of the transaction;

• standard fees collected by financial institutions for the establishment and administration of financial accounts (such as RRSPs); and

• normal per-transaction charges for security trades in the context of year-end tax-loss selling programs.

More generally, the Explanatory Notes state that standard fees for the provision of an ordinary financial account that is broadly offered in a normal commercial or investment context generally should not give rise to a reporting obligation in and of themselves, provided that other facts and circumstances do not demonstrate that the provider is otherwise considered to be an “advisor” in respect of a reportable transaction in which the account is used.
 
The Proposals also include a specific exception to the contingent fees hallmark for fees for the preparation of scientific research and experimental development (SR&ED) claims, even if such fees are contingent on the tax benefits arising therefrom.

Confidential Protection Hallmark

The Proposals do not include changes to, or revised explanatory notes about, the confidential protection hallmark. 

Contractual Protection Hallmark

The Proposals include a welcome new exception from the contractual protection hallmark for contractual protection provided as an integral part of certain M&A transactions, provided such protection is intended to ensure that the purchase price paid in the transaction takes into account any liabilities of the target business immediately prior to the transaction and is obtained primarily for purposes other than to achieve any tax benefit from the transaction or series. The Explanatory Notes state that this new exception is intended to apply to standard tax representations, warranties and indemnities between a buyer and seller in an M&A transaction, as well as standard representation and warranty insurance policies. Notably, the new carve-out does not distinguish between unidentified risks and historic tax risks specifically identified in the diligence process. This new exception should alleviate concerns that the broad drafting of the contractual protection hallmark would in and of itself require reporting in respect of almost all typical M&A transactions.
 
The new exception replaces the carve-out from the contractual protection hallmark in the previous version of the rules for protection arising in the context of normal commercial transactions, which does not extend protection for an avoidance transaction. This previous carve-out had been criticized as too limited given the breadth of the avoidance transaction definition, including in the context of M&A transactions. While the new exception potentially addresses these concerns in the M&A context, it is narrowly tailored to M&A and leaves open broader application of the rules to other normal commercial transactions that typically include some form of protection with regard to intended tax treatment.
 
While the general tone of the Explanatory Notes suggests that such transactions are also not intended to be caught, absent further guidance from Finance or the CRA, taxpayers and advisors may choose to err on the side of caution in such cases.

NOTIFIABLE TRANSACTIONS

Under the notifiable transaction rules, the Minister will be entitled from time to time to designate certain types of transactions or fact patterns as being subject to a reporting requirement. A “backgrounder” was released with the original February 2022 version of the rules describing six different kinds of transactions which may be so designated. The Proposals for the notifiable transaction rules do not make any further reference to such backgrounder, nor do the Explanatory Notes offer any new insight as to what kinds of transactions will be designated. Notably, the Proposals continue to contemplate that new transaction types may be designated in such manner as the Minister considers appropriate, including through the CRA website.
 
The Proposals also retain the previously announced very broad concept of “substantially similar” transactions to those which are specifically designated as being subject to reporting (as discussed in our 2022 whitepaper).
 
The Proposals introduce a new due diligence defence under the notifiable transaction rules for taxpayers participating in a transaction who have exercised appropriate care, diligence and skill in determining that a transaction is not notifiable. The Explanatory Notes indicate that this standard will generally be satisfied where a taxpayer has asked its advisors about potential reporting obligations and been informed that no such reporting is required.
 
The Proposals also replace the previously announced exception for “secondary or ancillary financial services” provided by certain financial institutions with a broader exception applicable to any promoter or advisor, provided such person does not know, and should not reasonably be expected to know, that the transaction was notifiable. The Explanatory Notes indicate that this exception is intended to narrow the categories of advisors (which can include non-tax experts) that will be subject to reporting, suggesting that whether an advisor should reasonably be expected to know that a transaction is notifiable will depend in part on the nature of the advisor’s involvement (in the transaction) and expertise. For example, the Explanatory Notes indicate that an investment banker who plays a lead role in managing the implementation of a notifiable transaction would normally be expected to be aware of the transaction’s purposes and objectives, whereas advisors providing more ancillary services or with narrower mandates (which may include for example local counsel providing country-specific advice in a multi-jurisdictional transaction) may not be expected to know that a transaction is notifiable.

CHANGES APPLICABLE TO BOTH SETS OF RULES

Reporting Deadline

The Proposals extend the reporting timeline from 45 days to 90 days. However, the original concept that the reporting deadline is triggered off the earlier of signing and execution for a particular transaction remains unchanged.

Joint and Several Liability

Under the Proposals, the joint and several liability provisions of the original rules (whereby all persons who are liable to a penalty for failure to report under the rules would be jointly and severally liable for such penalty) have been repealed.

Exception for Advisors Providing Clerical and Secretarial Services

The Proposals clarify that the exception originally included in a prior draft of the rules for a person providing clerical or secretarial services is included for greater certainty, noting that such persons would not normally be expected to be subject to reporting under the rules in any case. This is a welcome clarification, as it suggests that a broader range of limited-mandate advisors are likely also not meant to be caught.

Solicitor-Client Privilege Exception

The Proposals include a welcome change to the exception from reporting for information protected by solicitor-client privilege. Under the revised Proposals, this exception will be available for any person (as opposed to lawyers only) in respect of information that is reasonably believed to be protected by solicitor-client privilege. This exception will therefore apply to information in the hands of taxpayers and non-legal advisors (such as accountants) provided there is a reasonable belief that privilege applies.

EXTENDED REASSESSMENT PERIOD RULES UNCHANGED

It is notable that the Proposals do not revise the previously released rules for extending the normal reassessment period in respect of reportable and notifiable transactions for which a required information return has not been filed. The current drafting of these rules has been widely criticized as imposing an extended reassessment period on a taxpayer that has fully complied with its own reporting obligations by virtue of another person (such as an advisor in respect of the transaction) not having also complied. This proposal remains a significant concern.

For more information, please contact:

Andrew Spiro               +1-416-863-3165
Lara Friedlander          +1-416-863-5278

or any other member of our Tax group.