Introduction – What is a "Wash Transaction"?
Taxpayers who have more than $30,000 in taxable sales are required to register with the Canada Revenue Agency ("CRA") and collect the GST/HST on their goods and services sold. For many businesses, this amount is forwarded directly to the CRA once it is netted out against expenses, which are claimed back as Input Tax Credits ("ITCs").
However, as we have discussed previously in our articles, the GST/HST is meant to be an "end-user" tax; that is, only the final user or consumer of a product or services is meant to be paying the GST/HST.
That means that any business that deals with other registrants (businesses) typically pays the GST/HST to its suppliers and then claims the associated expense back from the CRA as an ITC. In these circumstances, no actual net tax has been collected by the CRA, as the flow of funds circles right back into the original payor's bank after being remitted by the supplier to CRA, and then refunded to the registrant's bank account.
This type of transaction is referred to as a "wash" for the reason that no real tax revenues have been generated by CRA, and the funds are simply changing hands from one registrant to another (albeit through the CRA's bank account).
GST/HST, ITCs and Cash Flows
The wash transaction is just another part of business for most registrants. When they pay for expenses they know they'll get the funds back, but depending on their filing frequency, this can take time. Needless to say this can eat into a business' cash flows significantly.
On the other hand, many businesses are structured through individual legal entities, and thus different registrants, perhaps all owned by the same parent corporation or individual shareholder. Take for example a retail business operating through a corporation that is owned by a parent corporation. The parent corporation holds the real property in which the business is operated for civil liability purposes. The parent company for accounting purposes also charges rent to the retail operating corporation. This is commercial rent, and thus is a "supply" for GST/HST purposes and GST/HST is collectible on the rental amounts.
For income tax purposes, this is not a problem as the rent can be accrued using normal accounting methods. However, even if no actual payment of underlying rent is made, there is still a requirement of the parent company to collect and pay GST/HST on the rental income. Thus, parent company is required to remit this amount to the CRA in the reporting period it is paid, and the retail business claims an ITC. The amount comes back into the business group through the retail company through the ITC claim, but it can often take time, particularly if either of the registrants reports on a yearly or quarterly basis.
It is obvious that this can lead to disruptions in the cash flows of either of these businesses, and it makes no real public policy sense to artificially create a cash flow crisis in this circumstance where a business has been structured in a certain manner for purposes other than tax. Thus, the Excise Tax Act has a solution to this cash flow problem.
GST Election for Transaction to be Deemed at Nil Consideration
Section 156 of the Excise Tax Act was specifically drafted by the Department of Finance to address the cash flow issue for Canadian businesses in the example just discussed. This section allows two related registrants to elect for the services to have been rendered for nil consideration for the purposes of the GST/HST. This means that in our example, the registrants and their owners won't need to worry about HST on rents being payable and held by the CRA for months at a time without interest paid.
But registrants need to be aware before they attempt to elect that the rules surrounding who may elect are very strict; if a pair of registrants does file the election and a later GST audit determines that they were not eligible, penalties and interest will apply.
The basic rule as described in the Excise Tax Act is that there are two conditions precedent for the election to be applied to a transaction:
- The transaction must be a "wash transaction"; and
- The parties to the transaction must each be a "specified member" of a "qualifying group".
The terms "specified member" and "qualifying group" are both defined in the Excise Tax Act and the legislation is meant to be applied strictly. In essence, the Act itself creates a complete code as for which types of registrants qualify to take advantage of section 156. It is beyond the scope of this article to list all of the factors that must be considered, and it is important that registrants receive proper advice from an expert Canadian GST lawyer that is tailored to their specific circumstances before they file the GST election and begin operating in this manner.
GST Tax Tips – Planning Your Business Structure to Anticipate Cash Flows
What the above analysis of wash transactions and section 156 of the Excise Tax Act demonstrates is that businesses need proper legal advice and GST tax planning if they are to operate as efficiently as possible. Not only will an experienced Canadian tax lawyer be able to help with the corporate and income tax structuring, taking into account the rules surrounding GST/HST can also help you with your day to day operations.
If you are planning on starting a business, or believe that your operation is not as tax efficient as possible, book a consultation with one of our Certified Specialist Canadian tax lawyers. We can provide a holistic analysis and plan for all types of contingencies as the pertain to corporate, civil, income tax and GST/HST. Cash flow is just one of the issues that we can help you plan around, but it could be the difference between a profitability and loss.
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.