Revised mandatory disclosure rules create new tax reporting requirements

A set of new mandatory disclosure rules were passed into law on June 22^nd, 2023. These mandatory disclosure rules are comprised of three sections: reportable transactions, notifiable transactions, and reportable uncertain tax treatment. Despite these rules being intended to tackle aggressive tax planning, there is significant concern that ordinary tax planning done by middle market companies will be captured under the scope of the new rules. Understanding these requirements will be vital to maintaining compliance with the goal of avoiding hefty failure to file penalties and extended reassessment periods.

Reportable Transactions

A reportable transaction is an avoidance transaction where one or more of three hallmarks is present. An avoidance transaction is a transaction where one of the main purposes of the transaction, or series of transactions which includes the avoidance transaction is to obtain a tax benefit. These avoidance transactions could include regular tax planning, like filing tax elections, that are explicitly permitted by the Income Tax Act

The three hallmarks are contingency fees, confidential protection, and contractual protection (i.e., insurance or another form of protection that protects against the failure to achieve a tax benefit or offsets costs in a dispute regarding the tax benefit). The legislation carves out certain situations where these hallmarks will specifically not apply, thereby making the transaction not a reportable transaction. For example, the contingency fee hallmark is not triggered by fees to prepare Scientific Research and Experimental Development (SR&ED) reporting form, and standard terms in an arm’s length business sale transaction will not trigger the contractual protection hallmark in many cases.

Every person or entity for whom a tax benefit results or the person who enters into the reportable transaction on behalf of that person is expected to report that filing 90 days from the earlier of:

• When the transaction is entered into;
• When the person is contractually obligated to enter the transaction; and
• If both types of filers listed above enter into the reportable transaction, then the day on which the transaction is entered into.

The penalty for failing to file accrues for each week the failure to file continues. For corporations with a carrying value of assets of $50M or more, the penalty accrues at a weekly rate of $2,000 to a maximum of the greater of $100,000 or 25% of the tax benefit from the reportable transaction. For all other entities and individuals, the penalty accrues at a weekly rate of $500 to a maximum of the greater of $25,000 or 25% of the tax benefit from the reportable transaction.

Reporting is required for all reportable transactions entered into after June 22, 2023. Some transactions or series of transactions may overlap June 22, 2023. The CRA has clarified:

• If a taxpayer contracted to enter a reportable transaction before June 22, 2023, but entered the transaction after June 22, 2023, the transaction should be reported 90 days from the latter day.
• If a series of transactions began prior to June 22, 2023, the taxpayer will become obligated to report by the first reportable transaction in the series entered into after June 22, 2023.

The reporting form for reportable transactions is Form RC312, Reportable Transaction and Notifiable Transaction Information Return.

Notifiable Transactions

A notifiable transaction is a transaction or a series of transactions that is the same or substantially similar to a list of specifically identified transactions and a series of transactions designated by the Department of Finance and Minister of National Revenue. In effect, this provision allows the government to identify transactions or series of transactions it believes are likely to be aggressive and collect additional information regarding these transactions.

There does not appear to be any publicly designated notifiable transactions yet, however, there is a list of sample notifiable transactions currently accessible on the Department of Finance website. It serves as a preview of the types of transactions that are intended to be captured under these rules.

Every person or entity for whom a tax benefit results or is expected to result or the person who enters into the notifiable transaction on behalf of that person is expected to report that filing 90 days from the earlier of:

• When the transaction is entered into;
• When the person is contractually obligated to enter the transaction; and,
• If both types of filers listed above enter into the notifiable transaction, then the day on which the transaction is entered into.

The penalty for failing to file accrues for each week the failure to file continues. For corporations with a carrying value of assets of $50M or more, the penalty accrues at a weekly rate of $2,000 to a maximum of the greater of $100,000 or 25% of the tax benefit from the notifiable transaction. For all other entities and individuals, the penalty accrues at a weekly rate of $500 to a maximum of the greater of $25,000 or 25% of the tax benefit from the notifiable transaction.

Reporting is required for all notifiable transactions entered into after June 22, 2023. The reporting form for notifiable transactions is Form RC312, Reportable Transaction, and Notifiable Transaction Information Return.

Reportable Uncertain Tax Treatment

These rules apply only to corporations that are reporting corporations. A reporting corporation satisfies the following criteria:

• The corporation was required to file a Canadian tax return;
• The corporation had at least $50M in assets at the end of the financial year coinciding with the tax year; and,
• Either alone or as part of a consolidated group, the corporation prepares audited financial statements in accordance with IFRS or another country-specific GAAP for publicly traded companies.

These corporations are required to file an information return where uncertainty about income tax treatment is reflected on their audited financial statements. An uncertainty would be, for example, where it is unclear the CRA’s position on reporting income from a particular source.

The corporation should report any reportable uncertain tax treatment when its income tax return is due. The failure to file penalty is $2,000 multiplied by the number of weeks during which the failure to file continues, up to a maximum of $100,000.

Reporting will apply to taxation years that begin after 2022. The reporting form for reportable uncertain tax treatment is RC313, Reportable Uncertain Tax Treatments.

Reassessment Periods

The general limitation period for the CRA to reassess a taxpayer is three or four years (depending on the type of taxpayer) unless an exception is met. Failure to file an information return required by the mandatory disclosure rules will extend the CRA’s deadline to reassess to three to four years (depending on the type of taxpayer) from the date the information return is filed. There is no such limitation period on applying failure to file penalties.

Due Diligence

For all three sections of the mandatory disclosure rules, a due diligence defence exists concerning either the requirement to file or the imposition of the failure to file penalty depending on the applicable section. The due diligence defence applies to reportable transactions and reportable uncertain tax treatment where the filer can demonstrate they exercised the requisite degree of care, diligence, and skill to prevent the failure to file the applicable reporting form. In terms of notifiable transactions, the due diligence defence applies to the person for whom the tax benefit is expected to result, or the person who enters the transaction on this person’s behalf, if they exercise the requisite degree of care, diligence, and skill to identify whether the transaction is notifiable.

Advisors and Promotors

Advisors (including those who provide any assistance or advice with respect to creating, developing, planning, organizing, or implementing the transaction or series) and promotors of reportable and notifiable transactions may also have a filing requirement under these rules, independent of their client’s filing.

Putting these rules into practice

Now that these disclosure requirements are in effect, mandatory disclosure filings will be part of the ongoing tax compliance for middle-market companies. The CRA has begun releasing administrative guidance to assist taxpayers in navigating these new rules, including clarifying some of the uncertainty created by the legislative wording. However, it has also indicated its approach to applying the mandatory disclosure rules will develop as practical experience with these rules is gained. Middle market companies will therefore need to continue to monitor the development of these rules and their application going forward.