On December 13, 2018, legislation was passed implementing amendments to the Excise Tax Act (Canada) (the “ETA”) first announced in September 2017 affecting GST/HST on management and administrative services provided to private equity funds and other funds (referred to in the legislation as “investment limited partnerships” or “ILPs”) by their general partners. These new rules negate certain tax planning using general partner distributions in lieu of management fees that became popular after Ontario adopted the HST in 2010. Affected funds now have until February 11, 2019, to file an election that may mitigate the impact of the rules for 2018. Going forward, the ILP rules will add administrative complexity to GST/HST reporting for most investment funds organized as limited partnerships.
Implications of the ILP Rules
- GST/HST on General Partner Distributions in lieu of Management Fees. The ILP rules render taxable any management and administrative services supplied to an ILP by the general partner of that ILP. The GST/HST is levied on the fair market value of these services. This measure applies retroactively, effective as of September 8, 2017. When the new rules were first announced, there was considerable concern in the fund and advisory communities that payments of carried interest would be subject to GST/HST in addition to periodic general partner distributions that were paid in lieu of a traditional management fee (generally 2 percent of committed capital). While the policy intent of the new rules does not appear to extend to taxing carried interest distributions, ILPs should review their general partner entitlements in light of the new rules. In some cases, it may be simpler to revert to the traditional management fee (subject to non-recoverable GST/HST) paid to a separate management entity (usually a subsidiary within the fund group).
- Non-Resident Exemption. There is a relieving rule that deems an ILP to be a non-resident of Canada if 95 percent or more of the total value of all interests in the partnership is held by non-residents (subject to certain exceptions). Supplies to non-residents are generally not taxable under the ETA. Funds that have separate limited partnerships for residents of Canada and non-residents of Canada should investigate the relieving rule and ILPs may wish to “cleanse” a limited partnership that fails the 95 percent test if it is otherwise commercially feasible to do so. Non-resident partnerships with investors that are themselves limited partnerships or trusts should carefully review the exceptions to the relief. Where new funds are being established, consideration should also be given to establishing a separate limited partnership for non-resident investors.
- New Rules on Timing of Supply. In a departure from the normal timing rules for periodic billing, the new rules deem the supply of management and administrative services provided by a general partner to be made for consideration that becomes due on the last day of each billing period. In practical terms, this means that the stub period from September 8, 2017, to the end of the billing period (September 30 in the case of quarterly general partner distributions with calendar quarters) will not escape taxation and will require pro-ration of the period’s distribution to assess tax. Funds that revert to a traditional management fee paid to a separate management entity are subject to the normal timing rules.
- Services Rendered Prior to 2018 Budget Day. The new rules deem management fees for services supplied between September 8, 2017, and February 27, 2018, to have become payable on February 27, 2018. As a result, management services rendered between September 8, 2017, and February 27, 2018, should be reported in a monthly filer’s February 2018 return, in a quarterly filer’s Q1 2018 return, and in an annual filer’s 2018 annual return. Management services rendered by a general partner prior to September 8, 2017, are generally deemed to be a separate supply, and not subject to the new rules.
Selected Listed Financial Institutions
- ILPs as SLFIs. Under the new rules, ILPs will generally be treated as selected listed financial institutions (“SLFIs”) as of January 1, 2019, or, if the ILP so elects, as of January 1, 2018. As a SLFI, an ILP will ultimately pay a “blended” rate of GST/HST based on the provincial residency of its investors. An ILP with investors in lower-tax provinces (notably Alberta) may enjoy a lower effective tax rate.
- SLFI Election. ILPs have until February 11, 2019, to make the election for retroactive SLFI treatment to January 1, 2018. As there is no prescribed form for making the election, the ILP may elect by sending a letter to the Prince Edward Island Tax Centre containing certain detailed information set out in GST/HST Notice 308 (July 2018).
Fund managers and their advisors should consider how the ILP regime will affect their funds. In particular:
- By February 11, 2019, all ILPs should consider whether it would be advantageous to make the election to be treated as a SLFI for 2018.
- General partners that are monthly or quarterly filers should ensure that they have complied with all of the new rules, including reporting any management services rendered by the general partner between September 8, 2017, and February 27, 2018, in their return for the period containing February 27, 2018.
- General partners that are annual filers should ensure that they report any management services rendered by the general partner between September 8, 2017, and February 27, 2018, in their 2018 annual return, as the filing deadline is fast approaching.
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.