November 2014
Tax Bulletin
GST/HST Closely Related Election
Amendments – Tips & Traps
Nature of the Election
To streamline their GST/HST compliance and improve their GST/HST
cash flow, two "closely related" GST/HST registrants can relieve
GST/HST on taxable transactions between them by entering into a
joint election (the "Election") pursuant to subsection 156(2) of the
Excise Tax Act (the "ETA"). In addition to the benefits of the Election
for ongoing transactions, the Election can be useful to improve cash
flow in the context of reorganizations or "one-off" transactions with
significant dollar values.
The Election is generally available between two parties that are: 1
(a)
GST/HST registrants,
(b)
engaged exclusively in taxable commercial activities,
(c)
corporations resident in Canada or "Canadian partnerships" 2 or
a combination of each, and
(d)
"closely related" for GST/HST purposes.
To determine whether two corporations are closely related, the
criteria in section 128 of the ETA should be considered. 3 As a
straight-forward example, where a parent corporation owns not less
than 90% of the value and number of the issued and outstanding
shares of the capital stock of another corporation, having full voting
rights under all circumstances, the two corporations are closely
related.
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To determine whether two Canadian partnerships, or one such
partnership and a corporation, are closely related to each other, the
detailed rules in subsection 156(1.1) of the ETA should be consulted.
If, in the example above, a Canadian partnership were substituted
for the parent corporation, then the partnership and corporation
would be closely related.
To determine whether a registrant is engaged exclusively in a
commercial activity under the existing rules in effect until January 1,
2015, a registrant must satisfy one of the two following tests (the
"Commercial Activity Test"):
a)
all or substantially all 4 of the registrant's property (other than
financial instruments) was acquired (or manufactured, produced
or imported into Canada) for consumption, use or supply
exclusively for use in the registrant's commercial activity, or
b)
if the registrant has no property (other than financial
instruments), all or substantially all 5 of the supplies previously
made by the registrant were taxable supplies.
In practice, due to the restrictiveness of the Commercial Activity
Test, a newly formed partnership or corporation ("Newco"), without
any history of making supplies and without any property, 6 is
restricted from entering into the Election with a closely-related
supplier and thereby from obtaining GST/HST relief on the taxable
acquisition of business assets from the supplier. 7 This restriction
denies access to the Election in circumstances where it would appear
to be appropriate to allow the Election (i.e., to relieve the GST/HST
compliance and cash flow burden for closely related registrants, to
the extent that they engage in taxable transactions between them,
where doing so would not result in any tax loss to the government).
To overcome this restriction and satisfy the Commercial Activity Test,
parties have used a two-step planning technique (the "Two-Step
Technique"). In the initial step, Newco would acquire an asset of
nominal value and pay GST/HST (recoverable by input tax credit
(“ITC”) claim) on the nominal value. Once this initial transaction is
completed, the closely-related supplier could then transfer assets to
Newco under the Election without GST/HST applying.
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Amendments to Take Effect on January 1, 2015
To respond to these concerns about the limitations on the availability
of the Election, the federal government announced amendments in
its February 2014 budget (the "Amendments") to change the
criteria for qualifying for the Election effective January 1, 2015. The
amendments became law on June 19, 2014. 8
By adding "forward-looking" criteria to the Commercial Activity Test,
the Amendments are intended to allow Newco to access the Election
without using the Two-Step Technique. Newco would satisfy these
criteria if it were reasonable to expect that:
a)
Newco will make taxable supplies throughout the next 12
months,
b)
all or substantially all 9 of those supplies will be taxable supplies,
and
c)
all or substantially all 10 of the property (other than financial
instruments and property having nominal value) to be
manufactured, produced, acquired or imported by Newco within
the next 12 months will be for consumption, use or supply
exclusively in the course of Newco's commercial activities.
While elements of the prior Commercial Activity Test are preserved
by the Amendments, the Two-Step Technique will no longer be
available for Newco to qualify for the Election. Assets of nominal
value will be specifically excluded from consideration under the
Commercial Activity Test.
As of January 1, 2015, closely related persons entering into the
Election will be required to file the jointly completed and signed
prescribed Election form with Canada Revenue Agency ("CRA").
Formerly, the Election form had to be maintained on file for audit
purposes, but not actually filed with CRA. 11
In addition, the Amendments introduce joint and several liabilities for
the parties to an Election, or purported Election. 12
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Concerns Arising From the Amendments
While the intention of the Amendments - to permit Newco to make
the Election without resort to the Two-Step Technique - is
commendable, and other changes may improve (at least from the
CRA's perspective) the administration of the Election, they,
nevertheless, raise a number of concerns.
There remains considerable uncertainty regarding the proper
interpretation of the new "forward-looking" Commercial Activity Test.
Could it exclude a start-up business or a business in an initial
research and development phase? Such a business might not have
any taxable supplies during its first 12 months. What is meant by the
requirement that Newco make taxable supplies throughout the first
12 months? Could the election be denied if Newco sells all its
business assets within the first 12 months? Would it be sufficient for
Newco to make taxable supplies at any time during the next 12
months (e.g., in the 12th month)? Unfortunately, at this time it is not
clear how CRA intends to address these questions.
By excluding property of "nominal value" from the Commercial
Activity Test, the Amendments leave open the issue of how "nominal
value" will be interpreted and applied by CRA. Will nominal value be
interpreted in absolute or relative terms? That is, if Newco initially
has a $20,000 asset, but will subsequently acquire business assets
with a value of $1 million, would the $20,000 asset be considered to
have nominal value?
This uncertainty could increase the risk of CRA disallowing GST/HST
relief claimed under an Election for an acquisition of assets by
Newco. If CRA disagrees with parties relying on an Election made, or
purported to be made, to relieve GST/HST, then, in view of the
Amendments to impose joint and several liabilities against the
parties, CRA could assess either or both of the parties for the
uncharged and unremitted GST/HST, plus any applicable interest and
penalties. 13
There are new filing requirements for the Election. If these
requirements are not met after 2014, then the Election would be
invalidated and CRA could assess either or both parties for
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uncharged, uncollected and unremitted GST/HST, plus any applicable
interest and penalties. 14
Practical Tips - Addressing Concerns with the
Amendments
Given the uncertainty and limitations of the "forward-looking" test,
Newco could be worse off under the Amendments than under the
existing rules. The Amendments eliminate the ability to implement
the Two-Step Technique discussed above to access the Election.
Where Newco is acquiring business assets from a closely related
supplier, consider whether a variation of the Two-Step Technique
(the "Planning Technique Variation") could be utilized to access
the Election on the transfer of the assets (or at least most of the
assets).
Under the Planning Technique Variation, to qualify for the Election,
Newco could acquire property of greater than nominal value, pay
GST/HST (recoverable by ITC claim) on that preliminary acquisition
(whether from the closely related supplier or a third party) and
subsequently acquire any property from the closely related supplier
GST/HST-free under the Election. Again, if what constitutes nominal
value were measured in relative terms, then the Planning Technique
Variation could be problematic, particularly in view of the exposure
to joint and several liabilities under the Amendments.
Given these concerns and limitations, another consideration to be
borne in mind is that the joint election on the sale of a business or
part of a business under section 167 of the ETA could be available to
obtain GST/HST relief on the transfer of business assets to Newco
from a closely related supplier. Nevertheless, if Newco and the
closely related supplier were to have ongoing transactions between
them, consideration could be given to entering into the Election to
relieve those transactions from GST/HST.
A sale of real property is excluded from the application of a closely
related Election jointly made under subsection 156(2) of the ETA. 15
However, the same GST/HST cash flow relief as under the Election
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could be achieved by the vendor being relieved from charging and
collecting the GST/HST on the taxable sale of the real property and
the purchaser having to self-assess GST/HST and claiming an
offsetting ITC on the same return. 16
Finally, as of January 1, 2015, jointly completed and signed Election
forms will have to be filed with CRA on a timely basis to be valid.
Parties to an existing Election in place before January 1, 2015 will
have to file the jointly completed and signed Election form in 2015. 17
Even if the Election form had been filed before January 1, 2015, the
Election form would have to be filed again. 18
by Jamie Wilks and Carl Irvine
For more information please contact:
Toronto
Jamie Wilks
416.865.7804
jamie.wilks@mcmillan.ca
Toronto
Carl Irvine
416.865.7266
carl.irvine@mcmillan.ca
a cautionary note
The foregoing provides only an overview and does not constitute legal advice. Readers are
cautioned against making any decisions based on this material alone. Rather, specific legal
advice should be obtained.
© McMillan LLP 2014
1
Definitions of “qualifying member” and “qualifying group” in subsection 156(1) of the ETA.
2
The definition of “Canadian partnership” is in subsection 156(1) of the ETA. Each partner
of a Canadian partnership is either a corporation or partnership resident in Canada.
3
Paragraph (a) of the definition of “qualifying group” in subsection 156(1) of the ETA.
4
CRA has administratively interpreted “all or substantially all” to mean at least 90%,
although the jurisprudence suggests a lesser proportion could suffice, depending on the
particular circumstances. See, for example, Ruhl (W.) v. Canada [1998] G.S.T.C. 4 (TCC).
5
Ibid.
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6
Other than financial instruments within the meaning of subsection 123(1) of the ETA.
7
Does not satisfy paragraph (c) of the definition of “qualifying member” in subsection
156(1) of the ETA in effect until January 1, 2015.
8
S.C. 2014, c. 20, (Bill C-31, Royal Assent June 19, 2014), section 40.
9
Supra, footnote 4.
10
Ibid.
11
ETA, ss. 156(2) and (4)(b).
12
ETA, subsection 156(5). CRA can cancel or waive interest in excess of 4% of the
uncollected taxes pursuant to CRA’s GST/HST Memorandum 16-3-1 – Reduction of Penalty
and Interest in Wash Transaction Situations.
13
Ibid.
14
Ibid.
15
ETA, paragraph 156(2.1)(a).
16
ETA, subsections 169(1) and (4), 221(2), and 228(4) and (6).
17
ETA, ss. 156(2) and (4)(b).
18
ETA, subsection 156(2.01).
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