What the 2023 GAAR explanatory notes actually say about flow-through structures

In November 2023, the Department of Finance published explanatory notes for its amendments to the General Anti-Avoidance Rule (GAAR) in section 245 of the Income Tax Act. The amendments added an “economic substance” test: a transaction that lacks economic substance is more likely to be considered abusive.

Because a flow-through investor often sells the shares soon after buying them, accountants have reasonably asked whether that test puts flow-through strategies at risk. Finance answered the question directly, with a worked example.

What the example says

In Example 4, “Carly”, a high-income taxpayer, buys flow-through shares, negotiates a short holding period, and sells as soon as she can to limit her exposure. Finance concludes that the transaction “arguably has a significant lack of economic substance”. It then concludes that the rationale of the flow-through rules more strongly shows it is not abusive:

“Finding that subsection 245(2) applies to a straight-forward flow through share investment followed by a sale of the shares would undermine Parliament’s objective in implementing these programs and would render them ineffective. Therefore, the GAAR should not apply in this situation to deny Carly the benefits of investing in flow-through shares.”

Finance also notes that the issuer “does receive a real economic investment to finance exploration or development,” and that this investment “is not diminished by a rapid sale of the flow-through shares.”

What it does not settle

• Explanatory notes are not law. In Finance’s own words, they are “intended for information purposes only and should not be construed as an official interpretation of the provisions they describe.”
• The example describes a straightforward subscription followed by a sale. Every transaction still stands on its own facts and documents.
• The GAAR is applied case by case, and the notes don’t bind CRA or the courts.

Read the source

Also available from the Department of Finance Canada