2024 saw considerable changes to Canada’s general anti-avoidance rule (the “GAAR”), applying retroactively to transactions occurring on or after January 1, 2024. The Canada Revenue Agency (the “CRA”) has now offered guidance on the application of the amended GAAR through a webpage released on December 20, 2024 (the “Webpage).[1]

The Webpage provides examples of “tax avoidance schemes” to which the CRA would seek to apply the GAAR. These examples fall into three key categories:

  • surplus stripping;
  • creation of an artificial capital loss; and
  • discretionary trusts and the application of the 21-year deemed disposition rule.

Within each category, the CRA identifies a specific “targeted abuse” and “abusive arrangement.”

This article highlights select transactions the CRA has indicated will be subject to the GAAR, as outlined on the Webpage.[2] 

Surplus stripping

For “surplus stripping,” the targeted abuse involves transactions for the benefit of an individual shareholder or a non-resident shareholder that result in the withdrawal of a corporation’s surplus in a manner that reduces the tax base and/or returns capital beyond the investment made with after-tax funds.

The abusive arrangement in this category involves transactions undertaken to strip corporate surplus in a way that defeats the object, spirit, and purpose of sections 84, 84.1, and 212.1, as well as subsection 89(1) of the Income Tax Act (Canada) (the “Act”).

The Webpage outlines the following examples of surplus stripping where, in the CRA’s view, the GAAR would apply:

Example 1:

  • An individual holds Class B shares of Holdco with a high adjusted cost base (“ACB”) (on which the capital gains exemption was previously crystalized).
  • Subco transfers property to the parent Holdco in consideration for Class B Shares of Holdco.
  • This transfer results in a significant increase to the paid-up capital (“PUC”) of the Class B shares of Holdco held by the individual.

Example 2:

  • An individual holds:
    • common shares of Canco with a fair market value (“FMV”) of $850,000 and a nominal ACB; and
    • preferred shares of Canco (on which the capital gains exemption was previously crystallized) with a $850,000 FMV and ACB.
  • Canco redeems the preferred shares, triggering:
    • a deemed dividend of $849,999; and
    • an equivalent capital loss.
  • Under subsection 40(3.6) of the Act, the capital loss increases the ACB of the individual’s common shares.
  • The individual then transfers their common shares to Holdco in consideration for:
    • preferred shares with an ACB and redemption value equivalent to the $850,000 ACB and FMV of the common shares; and
    • new common shares of Holdco with a nominal value.
  • Holdco subsequently redeems the preferred shares without tax consequences.

Example 3:

  • Parent (a foreign corporation) holds common shares of Canco with:
    • an FMV of $200 million; and
    • an ACB and PUC of $100 million.
  • Canco holds common shares of Subco with:
    • an FMV of $2 million; and
    • an ACB and PUC of $40 million.
  • Canco sells its common shares of Subco to Forco (a subsidiary of Parent) for $2 million.
  • Following a horizontal amalgamation of Canco and Subco, the PUC of the merged corporation’s shares is $140 million.

Creation of an artificial capital loss

For the “creation of an artificial capital loss,” the targeted abuse is the offsetting of a capital gain with an artificial capital loss, resulting in the misuse and abuse of sections 38, 39, and 40 of the Act.

The abusive arrangement involves “value shift” transactions, where value is shifted from an existing class of shares to a newly issued class. The initial shares are then sold to a non-affiliated person, creating an artificial capital loss used to offset a capital gain.

The Webpage provides the following example of the creation of an artificial capital loss subject to the GAAR:

Example:

  • Canco declares a dividend on its common shares held by an individual, payable by the issuance of preferred shares with a high redemption value and low PUC (known as “high-low shares”).
  • The individual sells their common shares of Canco to a non-affiliated person for a nominal amount, resulting in a capital loss.

Discretionary trusts and the application of the 21-Year deemed disposition rule

The targeted abuse for “discretionary trusts and the application of the 21-year deemed disposition rule” is the indefinite deferral of the recognition of accrued gains on certain types of property, contrary to subsection 104(4) of the Act.

Subsection 104(5.8) of the Act serves to prevent the avoidance of the 21-year rule through trust-to-trust transfers that do not involve dispositions at fair market value. The abusive arrangement in this category involves circumventing the application of subsection 104(5.8) to avoid the 21-year rule.

The Webpage provides the following examples under this category:[3]

Example 1:

  • A trust approaching its 21-year anniversary (“Old Trust A”) holds property with a high FMV and a low ACB.
  • Canco, wholly owned by a newly established discretionary trust resident in Canada (“New Trust”), is or will become a beneficiary of Old Trust A per its trust indenture.
  • Old Trust A distributes, on a tax-deferred basis, its property with an unrealized gain to Canco.

Example 2:

  • A trust approaching its 21-year anniversary (“Old Trust B”) has non-resident beneficiaries and holds property with a high FMV and a low ACB.
  • Canco, wholly owned by the non-resident beneficiaries of Old Trust B, is or will become a beneficiary of Old Trust B.
  • The property of Old Trust B is distributed, on a tax-deferred basis, to Canco.

Takeaway

Taxpayers and advisers may wish to review the Webpage’s examples when considering tax planning transactions. Readers should be aware that these examples are not exhaustive, nor do they limit the Crown’s position with respect to the GAAR in new or ongoing cases.

To stay informed on updates to the Webpage, including the addition of examples, taxpayers and advisers can subscribe to the Business – Tax Information Newsletter electronic mailing list.[4] If you have any questions concerning the Webpage or the application of the GAAR, please contact a member of the Miller Thomson LLP Corporate Tax group.

[1] Canada Revenue Agency, “General anti-avoidance rule (GAAR)” (last modified 9 January 2025), online: <https://www.canada.ca/en/revenue-agency/programs/about-canada-revenue-agency-cra/compliance/how-combat-tax-evasion-avoidance/general-anti-avoidance-rule.html>.

[2] This article references corporate names including “Canco,” “Subco,” and “Forco,” as reproduced from the Webpage. These terms are not defined on the Webpage, but are understood from the Webpage diagrams and general context to mean “Canadian corporation,” “subsidiary corporation,” and “foreign corporation,” respectively.

[3] It should be noted that these example transactions have also been designated as a notifiable transaction for purposes of section 237.4 of the Act.

[4] Canada Revenue Agency, “Electronic mailing list – Businesses – Tax information newsletter” (last modified 11 October 2023), online: <https://www.canada.ca/en/revenue-agency/news/e-services/canada-revenue-electronic-mailing-lists/electronic-mailing-list-businesses-tax-information-newsletter.html>.