Introduction: Businesses, “Neutrality” and the GST/HST
In Canada, doing business comes with a great deal of different, and sometimes contradictory concerns. For example, a business owner will often do what is best to protect a corporation from civil liabilities, which will require a trade-off with other considerations such as taxes. This can lead to major tax inefficiencies that can even affect a corporation’s ability to operate in accordance with management’s plan.
In particular, under the Excise Tax Act, just as with the Income Tax Act, separate corporations, despite how they are owned, are considered to be separate “persons” and thus, for the purposes of the GST/HST, they have to be separate registrants. This means that how a business structures its corporate group can actually increase the amount of GST/HST payable by virtue of “sales” of goods or services between related entities.
Canada’s system of taxation, either commodity taxes or income tax, has at its core the idea of “neutrality”; that is, the various taxing systems are designed to theoretically eliminate tax planning in a consideration of how a business structures its overall affairs. Obviously, in practice this is not the reality, and the Department of Finance has thus over time created various ameliorative provisions to “plug the gaps” where commodity tax issues can effect how a business operates and plans its operations.
Commercial Rents and GST/HST
An apt example of this is a business that operates through a series of related corporations in order to protect assets such as commercial property from judgment creditors and/or seizure by secured creditors.
By way of example, suppose an individual operates a retail business through a corporation, and also owns the building through which the retail business operates. The individual business owner has incorporated the business to protect his or her personal assets from any civil claims, but may also be concerned that any claims against the business could jeopardize the building. Thus, the business owner chooses to open a second corporation to hold the commercial property. They also choose to accrue rent from the business to the property holding corporation to further protect some of the revenues. While this will not generally effect the individual owner’s bottom-line profits, the creation of this structure means that the operating company will now have to pay GST/HST to the holding company regardless if actual rent is paid or accrued, and the holding company will need to remit said GST/HST when collected. This means that one of the two corporations must have the spare cash available to pay to the Canada Revenue Agency (“CRA”) on a monthly, quarterly or yearly basis, depending on revenue size or a previous election to remit more frequently than required under the Excise Tax Act.
The creation of this type of structure does not really create any additional GST/HST liability for the corporate group, because the payment of GST/HST the rent by the operating corporation can then be immediately claimed back by way of Input Tax Credit (“ITC”) by the landlord Corporation. The real estate holding corporation remits the cash and so the entire transaction is a “wash” meaning the funds are in essence forwarded to the CRA only to be refunded to the payor. However, this has the obvious potential to create cash flow and timing issues due to the reporting periods and/or if the business is one that operates on thin margins. The Department of Finance has recognized this issue and taken steps to try and ease the burden through the creation of a special election.
GST/HST Election under Subsection 156(2)
To deal with this problem, the Department of Finance created an election under subsection 156(2) of the Excise Tax Act. That subsection, providing that all the conditions precedent are met, allows two closely related corporations in a “qualifying group” to deem that the rental payments (using the above example) are for nil consideration. This means that for the purposes of the GST/HST, no funds are paid, collected or remitted.
The irony of this election is that while the policy reason for its introduction was to remove the GST/HST as a concern between members of a corporate group, is the fact that the Department of Finance has drafted the definition of “qualifying group” quite restrictively, and in most cases counter-intuitively. This means that in order to take advantage of the relieving provision, registrants normally need detailed legal advice to ensure that they are onside of the rules in subsection 156(2) and must structure their affairs in accordance with the election. Failure to elect, or electing when not eligible can create huge bills on reassessment if the registrants are subjected to an audit and the CRA determines the election is not permissible.
Tax Tips: Planning for a “Qualifying Group”
As stated above the rules regarding what constitutes a “qualifying group” for the purposes of the Excise Tax Act are very complex, and so attempting to simply and breakdown these rules is not of much benefit to the casual reader.
If you are contemplating setting up a business, or are experiencing cash flow problems related to the GST/HST, come and talk to one of our experienced and knowledgeable Canadian tax lawyers. We can provide the analysis and advice that your business needs to reduce all forms of taxes owing, including the GST/HST, income taxes and the Employer Health Tax (“EHT”).