One step forward and two steps back: 2014 Budget proposes changes to section 156 Election (for closely related persons) and possible amendments to the Joint Venture Election Rules

The 2014 federal budget, tabled on February 11, 2014 ("Budget 2014"), includes various measures relating to indirect taxation that may provide relief to businesses. While our annual Stikeman Elliott Federal Budget Commentary provides an analysis and overview of the budget as a whole, we also wanted to draw your attention to several specific issues that, in our opinion, warrant some additional attention.

Goods and services tax / harmonized sales tax (GST/HST) election for closely related persons

While the federal Excise Tax Act (the "ETA") is generally well drafted, every so often unintended technical issues arise. One such issue occurs in the current language of section 156 of the ETA, which allows for a GST/HST election to be made amongst qualifying members of a qualifying group (i.e. certain closely related corporations and partnerships) ("156 Election"). A 156 Election generally allows Canadian resident, GST registrant corporations and partnerships which are engaged exclusively in commercial activities to make supplies to other similar corporations or partnerships in a closely related group without collecting any GST/HST by deeming the internal supplies to be made for nil consideration. One potential technical issue which can arise is caused by the definition of "qualifying member".

Under the current definition, a "qualifying member" of a qualifying group, is a GST-registered corporation resident in Canada or a Canadian partnership where "the registrant last manufactured, produced, acquired or imported all or substantially all of its property (other than financial services) for consumption, use or supply exclusively in the course of commercial activities of the registrant or, if the registrant has no property (other than financial instruments), all or substantially all of the supplies made by the registrant are taxable supplies." The issue with this wording is that a new corporation or a new partnership which has not yet acquired any assets, and which has not yet made any taxable supplies would not technically be considered a "qualifying member. In practice, in order to deal with this technical issue, new partnerships or corporations would often acquire assets from related parties in a two-step process by first acquiring a single asset or a few assets and paying tax on these assets. The related parties would then make a 156 Election, and finally the new corporation/partnership would acquire the remaining assets from the related person without any applicable GST/HST. From a policy perspective, there was really no reason to implement the two-step transfer in order to do a 156 Election, especially since the new partnership/corporation would have been entitled to full input tax credits for any GST/HST it paid to the related party.

This potential issue has finally been addressed in Budget 2014, whereby amendments have been proposed to the definition of "qualifying member" in the ETA in order to allow the election to be made where the registrant has no property (other than financial instruments "and property having a nominal value") and has not made taxable supplies if it is reasonable to expect that:

  1. the registrant will be making taxable supplies throughout the next twelve months,
  2. all or substantially all of these supplies will be taxable supplies, and
  3. all or substantially all of the property (other than financial instruments and property having a nominal value) to be manufactured, produced, acquired or imported by the registrant within the next twelve months will be for consumption, use or supply exclusively in the course of commercial activities of the registrant.

Based on this proposed definition, a new corporation or partnership should be able to elect under section 156 of the ETA even if it has no assets so long as it is reasonable to assume that it will be making taxable supplies "throughout the next twelve months".

This is great news for related parties that intend to set up a new corporation or partnership as a going concern, as they will no longer need to do the two-step transfer in order to have a 156 Election apply. However, it is not such good news where the intention is to wind up or amalgamate the new corporation/partnership shortly after acquiring assets from a related party. In practice, this is often done where a parent corporation spins out assets into a new corporation, which it proceeds to sell to an arm's length purchaser that intends to amalgamate with the new corporation. In these situations, the CRA seems likely to conclude that it is not "reasonable to expect" that the new corporation/partnership will be making taxable supplies throughout the next twelve months. Interestingly, in the Supplementary Information, the Department of Finance points out that Budget 2014 proposes to extend the availability of the 156 Election to new members, "provided that the new members continue as going concerns engaged exclusively in commercial activities". Thus it appears that the Department of Finance has purposely limited the election so that it will not apply in circumstances where the new corporation/partnership will be wound up or amalgamated shortly after acquiring the assets. It is difficult to see the policy reasons for limiting the election in these circumstances.

In addition, the definition of "qualifying member" has also been changed such that it is no longer enough that a new corporation/partnership has property: it must now have property with more than a nominal value. In circumstances where it is reasonable to expect that the new corporation/partnership will continue to make taxable supplies for at least 12 months, this should not be an issue. However, in the second type of situation discussed above - the situation in which the corporation/partnership is expected to be wound up or amalgamated shortly after acquisition - it is not clear that the former two-step process will continue to work unless the asset(s) which are transferred as part of the first step have more than a nominal value. In addition, since "nominal value" is not defined, there could be some question as to whether the first transfer is of nominal value. Based on the Tax Court of Canada decision in British Columbia Transit v. R., 2006 CarswellNat 22320, 2006 TCC 437, the word "nominal" in the ETA should not be confused with the word "adequate" and should be interpreted on a relative basis.

Finally, it should be noted that the changes are to have effect only for periods from January 1, 2015 and that the proposed amendments require that, to be effective, the 156 Elections will have to be filed with the Canada Revenue Agency ("CRA"). This means that "retroactive" elections (where the parties acted as if an election were in place but did not sign the form) will no longer be valid without the approval of the CRA. A 156 Election will have to be filed on or before the earlier of the day when the particular specified member, or the other specified members must file their GST returns for the period that includes the day on which the election becomes effective. For related parties that currently have a 156 Election in effect, this election will have to be filed before 2016. However, for some reason, the proposed legislation will not allow parties to file the election prior to January 1, 2015 (otherwise it is deemed not to be filed). In other words, if qualifying members have a 156 Election currently in effect they will have to wait until sometime on or after January 1, 2015, but before January 1, 2016, in order for the 156 Election to remain valid for any period starting on or after January 1, 2015. Taxpayers who have 156 Elections in effect should make sure that they note in their calendar to file these elections sometime in 2015 - or else the elections may not be valid.

GST/HST and joint ventures

Current GST/HST rules allow participants in certain qualified joint ventures to jointly elect to designate an "operator" of the joint venture as the person in charge for accounting for the taxes on behalf of the co-venturers with respect to the acquisitions, as well as the supplies, made in the course of the activities of the joint venture (the "JV Election").

However, the rules also restrict the availability of the JV Election for joint ventures involved only in the exploration or exploitation of mineral deposits or certain other prescribed activities, such as the construction and ownership of real property. In other words, co-venturers that are not carrying on qualified activities cannot currently benefit from this GST/HST compliance simplification.

Budget 2014 purports to simplify compliance by permitting all participants in a joint venture to make the JV Election "as long as the activities of the joint venture are exclusively commercial and the participants are engaged exclusively in commercial activities." It is noteworthy that this proposed measure will also include "complementary anti-avoidance provisions", though it is not clear at this time exactly what this will mean.

Budget 2014 does not include the customary draft legislative proposals as the Government invited businesses and other stakeholders to provide input about this proposed measure once it has released draft legislation later this year.