Canada: Classic Concepts In Commodity Tax, v.1

Last Updated: September 14 2011
Article by Paul V. Casuccio

What is the Issue?

Under the general GST/HST rules imposed by Part IX the Excise Tax Act (the "Act"), where parties come together in a joint venture (but not by way of partnership) each of the co-venturers must account separately for its pro rata share of the GST/HST collected by the joint venture, and similarly must claim input tax credits only for its pro rata share of the joint venture's GST/HST expenses. This is very much unlike the GST/HST rules applicable to partnerships, and it makes joint venture arrangements inflexible and more burdensome for commodity tax purposes, thus discouraging businesses from using joint venture structures and increasing the likelihood of accounting errors when they do.

However, in certain prescribed circumstances, section 273 of the Act can alleviate this problem, by allowing co-venturers to make an election such that an "operator" is elected to account for the GST/HST on all purchases and sales made by the participants in pursuit of the joint venture, thus relieving the co-venturers of their obligations to account for some of the GST/HST collected and some of the available input tax credits.

When is the Election available?

The "joint venture election" is only available in certain prescribed circumstances, and even then, only if a number of conditions are satisfied. Specifically, it is only available if:

(a) The joint venture must either be for the exploration or exploitation of "mineral deposits", or for a prescribed activity under the GST/HST Joint Venture Regulations. Among others, the prescribed activities relate to certain activities commonly performed in the following sectors/industries:

(i) Development and management of real property

(ii) Natural gas

(iii) Electricity

(iv) Waste Disposal

(v) Pulp and Paper

(vi) Horse Racing

(vii) Farming

(b) The operator must be a "registrant", within the meaning of the Act.

(c) The operator generally needs to be a participant in the joint venture under a joint venture agreement, but there are certain circumstances where the Canada Revenue Agency ("CRA") may administratively allow for a non-participant to act as the operator. In addition, there is some question as to whether a bare trustee can act as the operator. Although the CRA has generally taken the view that a bare trustee cannot be a participant and accordingly cannot be an operator, a 2007 Tax Court decision held that a bare trustee could be a participant in certain circumstances.

(d) The joint venture is neither a partnership nor a corporation. The distinction between joint venture and partnership can be very fine, and there is both jurisprudence and CRA guidelines to be analyzed in making this distinction.

(e) The joint venture must be created by an agreement in writing. However, it is critical to note that the election can be made prior to the effective date of this written agreement, and in some cases, to be effective, the election must be in place before the written agreement is effective.

(f) The election must be made jointly in a prescribed form containing prescribed information, must be acknowledged by the parties and the form is to be retained with the operator for auditing purposes.

There is a particularly important issue to be faced by co-venturers with respect to the acquisition of real property and the application of the joint venture election to such an acquisition. Where a joint venture intends to acquire real property and account for it pursuant to a joint venture election, it is highly recommended that a strict review take place prior to the acquisition, to ensure that the joint venture and the co-venturers are in the best possible position to argue that the GST/HST on such an acquisition could properly be accounted for by the operator.

How does the Election work?

The election has the effect of deeming the operator to be the only person in the joint venture making the supplies, acquisitions and importations in connection with the joint venture, even if those supplies, acquisition, or importations were made by one of the co-venturers, through the operator, on behalf of the joint venture. As such, it is the operator that collects any GST/HST exigible on supplies made by the joint venture and claims any input tax credits to recover GST/HST that became payable in respect of the joint venture's acquisitions or importations. The election also deems supplies of property and services made by the operator to the co-venturers not to be supplies, thus not subject to GST/HST.

However, the election has no effect on commercial activities that the co-venturers perform directly, without involvement of (i.e. not through) the operator. If these non-operator co-venturers do not carry out such direct activities, they are not required to register for GST/HST purposes.

Why should a joint venture make the Election?

There are some significant advantages associated with making the joint venture election:

(a) Accounting simplicity: the operator will account for the GST/HST on behalf of all the co-venturers, rather than each co-venturer needing to account for its pro rata share (and ensuring that it has all the proper documentation necessary to claim the input tax credits).

(b) Cost savings: reduced accounting steps and simplified accounting management will naturally reduce the overall cost of the joint venture for each of the co-venturers. In addition, with only one entity subject to audit by the CRA in respect of the joint venture, audit costs are also significantly decreased.

However, making the election is not without some risk; some additional matters to consider include:

(a) Uncertainty: the legal distinction between a joint venture and a partnership is not entirely clear; making the election without certainty as to the identity of the business enterprise may have serious consequences, as discussed below.

(b) Joint and Several Liability: all co-venturers are jointly and severally liable for GST/HST with the operator, notwithstanding that they will not be responsible for any of the accounting.

(c) Potential for additional burden on the operator: not all co-venturers are required to make the election, and if some refuse to do so, a separate accounting scheme must be set up by the operator to accommodate them.

(d) Limited Scope: the simplified mechanism is only available to activities within the joint venture relationship. If certain transactions step outside the boundary of the joint venture, the participant(s) cannot rely on the benefits of the election.

Where can the Election go wrong?

There are many ways in which co-venturers may suffer from inappropriate use of the joint venture election. Some of the common issues include:

(a) A failure to actually complete the required documentation to make the election.

(b) The election was invalid because not all of the requirements described above were satisfied.

(c) The business enterprise was actually a partnership and not a joint venture, or developed into a partnership after initially being formed as a joint venture.

(d) After making the election, the co-venturers accounted for GST/HST inappropriately. For example, non-operator co-venturers are not entitled to input tax credits on purchases made through the operator if the election is in place.

There are serious consequences associated with misuse of the joint venture election, including but not limited to: reassessment by the Minister, penalties, interest, liability for unpaid taxes as well as the administrative burden of having to re-file tax returns for the operator and the registration of each of the co-venturers and completing their respective GST/HST returns (including the necessary gathering of documents and calculation of pro rata share).

The Bottom Line

The joint venture election is available to business venturers to allow more flexible and efficient accounting practice. It offers a simple solution to a cumbersome challenge faced by all joint ventures, but to be effective, the requirements of the election must be satisfied before making the election and compliance with the conditions of the election must be maintained throughout the life of the joint venture.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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