Quebec Clamps Down on Aggressive Tax Planning



Luis Millan for The Lawyers Weekly

March 19, 2010

Nearly six months after the Quebec government took the unusual step of unilaterally rolling out new artillery against aggressive tax planning in an unabashed bid to shore up tax revenues in the name of social justice, the federal government announced it was heading in the same direction.

Though Finance Minister Jim Flaherty did not introduce immediate measures to tackle aggressive tax planning, the 2010 federal budget unveiled plans to hold public consultations on proposals to require the reporting of certain tax avoidance transactions. While similar to the reporting regimes of the U.S., the U.K. and most recently, Quebec, the proposed regime by the feds is expected to be less inclusive.

The new reporting requirement will apply to avoidance transactions under the existing provisions of the General Anti-Avoidance Rule (GAAR) if they meet at least two of the three tests. According to the federal budget, these so-called "hallmarks" include cases when the fees of promoters or tax advisors are contingent on the tax benefit obtained from the transaction; the promoter or tax advisor insists on confidentiality about the transaction; and the taxpayer or the person who entered into the transaction for the benefit of the taxpayer obtains "contractual protection."

The additional information reporting requirements "should not come as a surprise to the tax community, given the measures to combat aggressive tax planning in Quebec and other countries," observed Mark Brender, a partner with Osler, Hoskin & Harcourt LLP, practising in the firm's Montreal office in the tax department.

"Based on the (federal) budget proposals, it does not appear to be taking as strict or hard approach as some of the other jurisdictions, such as Quebec. The Quebec measures are considered to be somewhat harsh by imposing a harsh penalty, which is really making the tax advisory practice much more difficult and challenging in creating additional uncertainty for businesses, operating in and outside of Quebec, with connections to Quebec."

The Quebec Department of Finance introduced controversial measures, effective as of Oct. 15, 2009, targeting aggressive tax planning - defined as a transaction that complies with the letter of the law, but abuses its spirit. While first promised in the 2008 provincial budget, the Quebec government forged ahead following a ruling by the Quebec Court of Appeal that confirmed the application of the province's general anti-avoidance rule (GAAR) against pre-packaged tax avoidance schemes designed to avoid provincial income tax such as the so-called Quebec Shuffle and the Truffle.

Besides extending the limitation period for Revenue Québec, the provincial tax authority, to assess transactions under the provincial GAAR, it introduced harsh penalties for transactions that are subject to the GAAR - all of which can be avoided if transactions are disclosed in accordance with the two new disclosure regimes. Under the new regimes, mandatory disclosures are triggered when transactions involve confidentiality or conditional remuneration arrangements.

There is also a voluntary early disclosure that taxpayers can use to report transactions that may be subject to the GAAR - a disclosure regime that has ostensibly divided the tax advisory community. Some advisors believe that all transactions should be disclosed, and that they should literally bombard the provincial tax authority and "report everything under the sun," as one put it, while others believe that it is appropriate to only disclose transactions where there is a real, perceived risk of being subject to the GAAR.

"What Quebec is trying to do is put the taxpayer and tax advisor into a box," remarked Mark Potechin of Montreal law firm Phillips Friedman Kotler. "GAAR is a provision of the tax law that is a little bit like pornography. We don't know how to define the tax benefit which is abusive, but we know it when we see it."

If, however, transactions are not disclosed on a timely basis, Revenue Québec may assess the transaction beyond the normal limitation period, as well as impose a penalty of 25 per cent of the amount of the tax benefit if it is ultimately found to be subject to the GAAR. While taxpayers may submit a due diligence defence to avoid the penalty, some tax litigators point out that it is so narrow that it will no doubt eventually be tested before the courts.

Guy Gagnon, a partner with McCarthy Tétrault's tax department in Montreal, wonders what will happen if a taxpayer relies on an opinion issued by lawyers concluding that GAAR does not apply to a transaction or series of transactions. "It appears that the submission of a legal opinion to tax authorities will not be an acceptable due diligence defence," said Gagnon, a tax litigator for over 25 years. "If that is the case, it is at the very least arguable. Suggesting that a legal opinion - which under normal circumstances, if not all cases, you would not offer to submit to the tax department because of the privilege associated with that opinion - is not a valid due diligence defence, certainly seems to be suggesting that the tax department sees these measures as a very big source of new files for assessment purposes."

A submission by the Canadian Bar Association went further, expressing concerns over a taxpayer's ability to establish a defence of due diligence without compromising the taxpayer's right to solicitor-client privilege. "To the extent that the application of GAAR depends on mixed questions of fact and law regarding the technical provision of the Act and 'the object and spirit' of such provisions," the CBA points out that a taxpayer's ability to establish due diligence will often rest on having obtained legal advice.

"Taxpayers cannot be placed in the position of having to choose between a penalty and waiving a fundamental legal right," said the CBA in a report submitted when the Quebec government was holding a public consultation over the issue of aggressive tax planning.

While acknowledging that some businesses and advisors push the boundaries of tax planning schemes too far, there seems to be widespread accord within the tax advisory community that the Quebec measures are draconian and may lead to a climate of uncertainty.

"What Quebec did was kill the proverbial mouse with an elephant shotgun," said Brender. "Tax authorities have a legitimate concern that there is some tax planning that crosses the line of acceptable creative tax planning. But where that line is, is somewhat blurry. And to impose a harsh penalty creates difficulty where there are transactions that come close the line or fall into that blurry territory."

All quotes by Guy Gagnon translated by the author.
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