Introduction: GST/HST and Input Tax Credits
When a taxpayer carries on a commercial activity it inevitably incurs the additional expense of GST/HST payable on its supplies. However, because the GST/HST is a consumption tax, in most circumstances only the end user or consumer is ultimately charged. In order to ensure this, the Excise Tax Act ("ETA"), which levies GST/HST, contains provisions that allow businesses to have their GST/HST expenses credited or refunded. These credits and refunds are referred to as "Input Tax Credits" ("ITCs") and serve to ensure that only end-users are responsible for paying the GST/HST in Canada.
Business Structuring and the Commercial Activity Problem
For a whole myriad of reasons, both tax related and non-tax related, businesses in Canada choose to arrange their operations and ownership structures in many different ways. One of the most common corporate organizations suggested by experienced Canadian tax lawyers for private Canadian businesses is for the shareholders to own their shares in an operating company through a holding company. There are various business and tax reasons for this method of structuring such as to protect the business should the operating company run into civil liabilities, lawsuits and government fines. More advanced structures also sometimes include trusts or partnerships.
However, the use of these types of entities created a problem with respect to GST/HST expenses due to the fact that because holding companies and the like incur expenses, they usually cannot be argued to be engaged in a commercial activity as any commercial activity takes place primarily or solely through the subsidiary operating corporation. The rules of the ETA were written originally to require that any registrant attempting to claim ITCs would have to be engaged in a commercial activity to do so, creating obvious issues for businesses that include holding companies, trusts or partnerships.
In order to alleviate this problem, the ETA contains rules that allow a holding company to claim ITCs on property or services it acquires if it can be reasonably considered that the property or services are related to the shares or indebtedness of another corporation related to the holding corporation. These rules also contain a number of conditions precedent that must be met including a requirement that all or substantially all of the property of the other corporation is for consumption use or supply in the course of a commercial activity. If the test is met, a holding company is then deemed to have acquired the property or services in the course of a commercial activity and thus can claim ITCs on the outlays.
The CRA Moves to Narrow the Eligibility Rules for Holding Corporations to Claim ITCs
In 2018 the Department of Finance released draft legislation related to the GST/HST holding company rules in order to replace the previously simple qualification tests that had been interpreted liberally by the Tax Court of Canada. In essence, the new amendments codified the rules by listing specific activities and situations in which a holding company would be allowed to claim ITCs on its expenses; if the holding corporation incurs costs which are related to an unlisted activity or circumstance, it will not be eligible to claim ITCs.
The new rules allow a holding company to claim ITCs only if they have acquired property or services for at least one of the following purposes:
- Specified transactions involving the shares and debt of a qualifying operating corporation;
- The issuance or sale of shares or debt of the holding company if the proceeds are transferred to the operating corporation and used exclusively in the operating corporation's commercial activities; and
- Other activities that meet a property test requiring that all or substantially all of the property of the holding company is shares or debt of the operating corporation.
Additionally, once a holding corporation meets one of these tests, it must also must be related to the operating company in order to claim ITCs. In this case "related" is a term defined under the ETA and is subject to strict rules.
The Problem of Partnerships and Trusts and the "Related" Rules
The 2018 amendments, while narrowing the scope for holding corporations also created a problem for corporate structures that include partnerships or trusts. The new rules implicitly excluded trusts and partnerships from eligibility by relying on the "related" test which makes it difficult for a corporation to demonstrate sufficient control over the operating entity to be considered "related".
Thus, in May 2019 the Department of Finance released further amendments to the ITC regime that was meant to address this problem. The new proposed rules would allow partnerships and trusts at the parent level to claim ITCs on property and services incurred on behalf of a subsidiary corporation if they meet the same test enumerated above. This means that when a trust or partnership owns sufficient shares of an operating corporation it can claim ITCs, but does not solve the reverse problem. To date neither the CRA or the Department of Finance have addressed this uncertainty.
Eligibility Expansion for Holding Companies to Claim ITCs
The only other significant change introduced by the Department of Finance in the 2019 amendments was a slight expansion of eligibility for holding corporations to qualify to claim ITCs. Previously, under the 2018 rules, holding companies could only claim ITCs if they owned no other assets besides shares or debt of an operating corporation which otherwise met the eligibility requirements and the GST/HST payble was incurred in relation to that specific holding corporation. Now, so long as the holding company's assets are primarily used in a commercial activity, they can claim ITCs for expenses related to a subsidiary. This change has done nothing to address the partnership and trust issue and means that business owners need to be especially careful in the planning of their structures if they wish to continue to claim ITCs on commercial transactions undertaken by parent corporations.
Tax Tip: Corporate Structural Planning
The introduction of the new rules means that businesses need to be especially careful and to plan wisely with respect to their corporate structuring in order to be able to continue to be eligible to claim ITCs on expenses incurred by all members of their corporate group.
Our Canadian tax lawyers have the experience and expertise to advise corporate clients with respect to the eligibility to claim ITCs; we can review current structures and advise what changes are necessary to stay onside the rules, or for new businesses we can create a structure that meets your business goals while remaining onside for GST/HST purposes. Being caught off-guard by a CRA tax audit could lead to denied ITCs, tax reassessment and possible tax penalties if your corporate structure does not meet the threshold.