On July 27, 2018, the Department of Finance Canada released new draft legislative proposals in relation to the GST/HST holding corporation rules, and issued the following additional documents:
- “Consultation Concerning the GST/HST Holding Corporation Rules”; and
- “Explanatory Notes Relating to the Excise Tax Act, Excise Act, 2001, Air Travellers Security Charge Act and Related Regulations.”
The holding corporation rules, as currently legislated in section 186 of the Excise Tax Act (ETA), allow a parent corporation (which is resident in Canada and a GST/HST registrant) to claim input tax credits (ITCs) for GST/HST paid on expenses in relation to the shares or indebtedness of a related operating corporation involved exclusively in commercial activities. The Department of Finance has proposed amendments to these rules and is also requesting input from industry stakeholders regarding a couple of other changes.
Legislative Proposals
Commercial operating corporation property test
The proposed changes would broaden the “commercial operating corporation property test” that a corporation related to a parent corporation must pass in order for the parent to claim ITCs under the holding corporation rules. The revised test would include property that is “manufactured or produced” by the operating corporation, an addition to the current wording used in the provision, which requires that, at the time the tax becomes paid or payable by the parent, all of substantially all (i.e., 90% or more) of the property of the related corporation is property that was last “acquired or imported” for use exclusively in the course of its commercial activities. This issue was initially brought up in a January 22, 2018 comfort letter released by the Department of Finance, which indicated that parent companies could be prevented from claiming ITCs that would otherwise have been allowed, had the related corporation’s property been acquired or imported, rather than manufactured or produced.
Input tax credits
The proposed changes also include specific requirements for a parent corporation to claim ITCs under the holding corporation rules, with certain conditions laid out in proposed amendments to paragraphs 186(1)(a), (b) and (c) of the ETA.
Under new paragraph 186(1)(a), a parent corporation may claim an ITC where it acquires or imports particular property or services for the purposes of:
- the disposing, obtaining, or holding of shares of capital stock or debt of an operating corporation; or
- the redeeming, issuing, converting, or modifying of shares or debt by an operating corporation.
Paragraph 186(1)(b) will allow a parent to claim ITCs on similar property or services, where the parent corporation raises capital through the issuance of its own shares or debt, and the proceeds are transferred to the operating corporation for exclusive use in commercial activities. In such cases, any ITCs will be limited in proportion to the use of the funds in the commercial activities of the operating corporation.
Under new paragraph 186(1)(c), ITCs will only be allowed to a parent corporation under specific circumstances. ITCs may be claimed in respect of a particular property or service where the parent is a holding corporation whose property is all or substantially all the shares and/or indebtedness of operating corporations, and the parent acquires or imports the property or service for a purpose other than an activity that is primarily in respect of the shares or indebtedness of a person that is neither the parent nor one of its operating corporations (i.e., consulting related to third-party investments); or an activity in the course of exempt supplies by the parent. However, the latter restriction specifically excludes financial services [as defined in subsection 123(1) of the ETA] that encompass any of the following activities:
- the lending or borrowing of shares or debt of an operating corporation of the parent;
- the issue, granting, allotment, acceptance, endorsement, renewal, processing, variation, transfer of ownership or repayment of shares or indebtedness of the parent or one of its operating corporations;
- the provision, variation, release or receipt of a guarantee, acceptance or indemnity in respect of shares or debt of the parent or one of its operating corporations;
- the payment or receipt of money as dividends (other than patronage dividends), interest, principal, benefits, or similar items in respect of shares or debt of the parent or one of its operating corporations; or
- the underwriting of shares or indebtedness of an operating corporation of the parent.
The proposed amendments related to ITCs will generally apply to properties or services acquired, imported, or brought into a participating province on or after July 28, 2018.
Consultation on further changes
In addition to the released legislative amendments, the Department of Finance has requested consultation on two other proposed changes to the holding corporation rules.
Related test
Where a parent company incurs GST/HST in relation to raising capital that is used by a related commercial operating company, the legislation deems those activities to be commercial activity of the holding company, allowing it to claim ITCs. Currently, a parent company need only be related to an operating company (i.e., at least 50% common ownership among the corporations) to be entitled to claim ITCs. This can lead to unfair tax situations. For example, a parent company holding a 51% interest in a commercial operating corporation would be entitled to claim ITCs in relation to any activities covered under the holding corporation rules, whereas any other investors in the same entity would be denied ITCs in relation to similar activities.
As a result, the Department of Finance has proposed changing the holding corporation rules to require a parent company to be closely related (i.e., at least 90% common ownership), rather than simply related, to a commercial operating company for the rules to apply. The tightening of this requirement is intended to restrict the holding corporation rules in a manner similar to other look-through provisions in the ETA, and ensure that the rules only apply in situations where there is sufficient integration between the parent and operating companies, such that they effectively function as a single entity.
Partnerships and trusts
Currently, the holding corporation rules apply only to parent corporations, and only in respect of the shares or indebtedness of a commercial operating entity that is also a corporation. As a result, situations can arise where a non-corporate person which essentially acts as the parent of another person involved in commercial activities is not entitled to claim ITCs in relation to the raising of capital, despite the fact that this would otherwise be allowed under the holding corporation rules, if the parties involved were corporations.
GST/HST rules are, by design, generally not intended to favour one business structure over another. However, certain other look-through provisions in the ETA apply specifically to corporations and, given the voting rights assigned to the shares of a corporation, it is relatively easy to quantify the percentage of common ownership among two or more corporations. Partnerships and trusts, on the other hand, usually do not have voting rights assigned to their interests, making it more difficult to quantify the extent of any common ownership. Notwithstanding any potential issues associated with determining the value of an interest in a particular partnership or trust, or in using some type of proxy for voting rights, the Department of Finance has proposed expanding the holding corporation rules to include partnerships and trusts, as part of its commitment to overall tax fairness.
Consultation period
Industry stakeholders are invited to submit any comments or concerns related to these proposed rule changes by September 28, 2018.