Disclosure increases transparency for clients.vladwel/iStockPhoto / Getty Images
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Enhanced mandatory disclosure rules, designed to increase tax transparency by requiring disclosure of specific types of transactions, have been in place since last summer, but accountants and lawyers are still working through scenarios and requesting additional guidance from the Canada Revenue Agency (CRA).
In the meantime, advisors need to become familiar with the rules so they can educate clients and connect them to tax and legal experts as needed.
“Advisors who do a transaction with income tax consequences for the transacting parties need to make it part of their due diligence,” says Barry Travers, partner and national leader of strategic tax initiatives at KPMG LLP in Toronto. “It’s very important to provide proper documentation and be as clear as possible about your review process.”
The rules differentiate between reportable and notifiable transactions. Reportable transactions are “avoidance transactions” that fall into one of three categories: a contingent fee arrangement, confidential protection, or contractual protection. Notifiable transactions match a list defined by the CRA that the tax agency finds to be objectionable.
“It’s not as if the transactions are not following the law,” says Mr. Travers. Rather, disclosures will “provide a population or a pool for tax authorities to review, to decide whether they want to audit them further and seek out further details.”
Disclosures must be submitted using Form RC312 within 90 days of entering into a transaction or 90 days of becoming contractually obligated to enter into a transaction, whichever is earlier. One challenge, Mr. Travers points out, is that a transaction may be part of a series that, for example, reorganizes assets before the closing date of a sale – but the clock may start counting down on the date of the initial transaction in that series.
“Most taxpayers are not waiting to the 89th day to report,” he says, noting that each transaction in a series could be considered a separate non-compliant filing. “All of a sudden, what looked like a single penalty has now grown into 10 or 15 different individual penalties, and they could be on both parties – both the vendor and the purchaser. So, the amount of the penalties could get very, very large very, very quickly.”
Transactions advisors may encounter
Debbie Pearl-Weinberg, executive director of tax and estate planning with CIBC Private Wealth in Toronto, says most advisors won’t run up against these new reporting requirements on a daily or even frequent basis. Still, advisors should watch out for situations in which they receive a fee attributable to the number of people who participate in a transaction or, less commonly, receive a fee to agree to indemnify a client should they fail to achieve a tax result or incur costs to dispute a tax result. If the main reason for the client entering into a transaction is a tax benefit, then they might be required to report the transaction to the CRA.
An example of a notifiable transaction advisors might encounter relates to the 21-year deemed disposition rule for trusts. If someone trying to avoid taxes at the 21-year mark transfers property from the trust to a new trust or a corporation with shareholders who are either a new trust or non-residents, that’s a notifiable transaction.
Since the rules were introduced, Ms. Pearl-Weinberg notes that the CRA has issued guidance that excludes some transactions or fees from the disclosure requirements even when a key purpose is to obtain a tax benefit. Examples include registered retirement savings plans administrative fees, fees for opening a trust bank account and tax-loss selling commissions, as well as loss consolidation transactions, purification transactions and foreign-exchange swaps, as long as they are not a step in a series of reportable transactions.
On the other hand, things can get murky. She provides the example of a promoter who has an idea for a tax-motivated transaction. They come to an advisor who gets a referral fee for the number of clients they bring to the promoter.
“They either end up engaging in the transaction or ... get to know some confidential aspect of the transaction. That’s an example of something where an advisor [may] have to report,” she says.
Incorporating the rules into your practice
“If an advisor sees a client who is entering into a tax-motivated transaction where the client gets a benefit, they should be telling their client to consult with a tax advisor to see if the client needs to report under these new mandatory disclosure rules,” Ms. Pearl-Weinberg says. “The client may need to report even if the advisor does not receive a fee requiring reporting on their part.”
James McCarthy, wealth advisor and client relationship manager at Nicola Wealth Management Ltd. in Vancouver, says although the day-to-day transactions he facilitates tend to be among the CRA’s listed exclusions, his practice has provided clients with a high-level overview of the rules. At the same time, he’s reassuring clients that transactions and strategies he has advised on or will advise on in the future – such as flow-through shares and estate freezes – have been exempted.
“Anybody who falls under this new reporting is going to be doing very complex tax strategies,” he says. “It doesn’t seem to be targeting even the high-net-worth market. It seems to be targeting the ultra-high-net-worth market.”
Jennifer Watson, managing partner with Watson Investments at Aligned Capital Partners Inc. in Oakville, Ont., also says most advisors aren’t engaging in transactions that are covered by these rules. Nevertheless, she points out that because the rules narrow the range of options available to some clients, “it becomes even more important for you to have the right advisor on your team to help with legitimate tax savings that are completely above board where you’re not going to be doing these extra disclosures.
“Understanding that really makes a difference in terms of the advice that you would give [and] who you could guide them to or not,” she adds.
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