As a result of the legislative amendments to the General Anti-Avoidance Rules (“GAAR”), many tax planning strategies are being reconsidered due to their lack of economic substance. Indeed, a recent change to the GAAR legislation introduced the assumption that a significant lack of economic substance in an avoidance transaction is an important consideration that tends to indicate that the transaction results in a misuse or abuse of the Income Tax Act (“ITA”). Considering that misuse or abuse of the ITA is usually the main source of litigation involving GAAR, it follows that taxpayers should be wary of any tax planning arrangements that significantly lack economic substance.
Pipeline transactions have long been used to prevent double taxation for shareholders, though they sometimes fall in a grey area when it comes to their economic substance. Do they remain viable tax planning strategies even with the recent legislative changes to GAAR?
The Canada Revenue Agency (“CRA”) recently issued guidance in which it reiterated its position to continue ruling favorably in respect of post-mortem pipeline transactions (see technical interpretations 2023-0987941I7 and 2024-1003541C6).
For post-mortem pipelines, the CRA specified that the transaction must adhere to the guidelines outlined in document 2018-0748381C6 to avoid the application of section 84.1, subsection 84(2), and section 245 (i.e., GAAR). According to these guidelines, the CRA would likely reassess a pipeline strategy where:
- The funds or property of the original corporation would be distributed to the estate in a short time frame following the death of the testator, or
- The nature of the underlying assets of the original corporation would be cash and the original corporation would have no activities or business.
For pipeline transactions following a trust’s realization of a gain on its 21-year anniversary, the CRA issued a ruling (i.e., 2023-0986521R3) in which it determined that none of section 84.1, subsection 84(2) or section 245 (i.e., GAAR) applied to such transactions. Although the ruling was issued prior to the application of the amended GAAR legislation, the CRA nonetheless specifically ruled that subsection 245(2) would not apply to these transactions, which indicates that the CRA would likely not consider such pipeline strategies to result in a misuse or abuse of the ITA.
While this guidance may be favorable for pipeline planning, it’s important to keep in mind that all transactions are analyzed by the CRA on a case-by-case basis, after a review of all the facts and circumstances surrounding each specific situation.
Nevertheless, it appears that pipeline strategies remain acceptable in the eyes of the CRA and should continue to be considered as an effective way to significantly reduce the tax burden resulting from a deemed disposition of shares resulting from the passing of a shareholder or the 21st anniversary of a trust.
Looking to put into place effective tax planning strategies while navigating the complex Canadian tax legislation? Please speak to your Crowe BGK tax advisor.