Written by: Darryl Rankin
If more than one corporation is under common control, what happens for sales tax purposes if one charges fees to another?
For example, Company A might charge Company B any of:
- Management fees
- Rent for the use of a building owned by Company A
- Fees for the services of Company A employees (Company A lends one or more employees to Company B, or has its employees perform services for Company B)
These arrangements might be set up for tax purposes, creditor proofing, or simply as part of good resource management within a corporate group.
The GST (Goods and Services Tax), HST (Harmonized Sales Tax), and QST (Quebec Sales Tax) all follow the same rules on this issue (this discussion does not apply to the provincial retail sales taxes in British Columbia, Saskatchewan, and Manitoba). For simplicity, we refer to all GST, HST, and QST as “GST” below. In an HST province, read it as “HST.”
Except for interest paid on a loan, intercompany fees are usually for “taxable supplies” and thus are subject to GST.
Provided Company B is carrying on a business of making taxable (or “zero-rated”) supplies under the GST and is GST-registered, Company B can claim input tax credits to recover all GST it pays to Company A, so the GST cost is just a temporary cash-flow cost. Nevertheless, there is still a cost, and the GST requires extra paperwork and accounting in addition to the cash flow.
For “closely related” corporations, an election is available to not have to charge this GST.
- “Closely related” basically means under common corporate control. For example, if Company A owns all the shares of Company B, or Company C owns both of them, then Company A and Company B are closely related.
From 1991 when the GST was first introduced, this “closely related corporations election” did not require the corporations to file anything with the Canada Revenue Agency (CRA). It was enough for them to simply agree that no GST would apply to the intercorporate charges and complete Form GST25 and keep it in their records in case of audit.
- Since 2015, however, the election must be completed on Form RC4616 (available from canada.ca) and filed with the CRA. Any old elections on Form GST25 are no longer valid.
This election may seem like mere paperwork since the government has no real loss if the GST is not charged. However, the CRA is a stickler for compliance and will assess the GST if the form has not been filed or was not filed in time.
One company that learned this lesson the hard way was Denso Manufacturing. It had an election in place in its records before 2015, and should have filed a Form RC4616 with the CRA during 2015 to keep the election running, but did not. In February 2016 it filed the form, mistakenly stating that it was to be effective from January 1, 2016 (instead of 2015). As a result, the CRA assessed Denso $30 million for not collecting GST from its related company in 2015. Under its “wash transaction” policy, the CRA waived the interest in excess of 4% of the tax, but this meant Denso was still charged $1.2 million in interest (and such interest is non-deductible for income tax purposes).
The CRA refused to allow Denso to amend the election to make it effective from 2015. Denso sought judicial review in the Federal Court, which upheld the CRA decision in 2020, saying it was reasonable. Denso appealed to the Federal Court of Appeal, which again upheld the CRA decision, in December 2021. Denso should have taken precautions to keep abreast of its compliance obligations (Denso has applied to the Supreme Court of Canada to appeal this decision, but leave will not likely be granted).
Castle Building Group ran into the same problem – it did not file the election on time. It filed Form RC4616 in December 2016 but made it effective only from that month. Later, in 2017, it tried to amend the election to apply from 2015, but CRA refused to allow the amendment. Castle applied to the Federal Court for judicial review of this decision, and the Court ruled in September 2021 that the CRA’s decision was reasonable. So, like Denso, Castle was stuck with an assessment for not having collected GST/HST from its related company. Again, the GST/HST is recoverable by the related company as an input tax credit, but, as with Denso, the cost of the interest imposed by the CRA was high enough to justify the Federal Court action.
If you manage corporations that charge fees or rent to each other without GST/HST applying, make sure to have them complete a Form RC4616 and file it with the CRA. Otherwise, if it is ever audited, the CRA will assess the corporation charging the fees or rent for the unremitted GST/HST plus interest and possibly penalties.
Also, make sure that you are not using the election for corporations that are not “closely related” as defined in the legislation.
If you have an existing arrangement with corporations that are not charging GST or HST and have not filed the election, but the CRA has not yet found the problem, it may be possible to eliminate all interest and penalties with a Voluntary Disclosure, combined with the CRA’s policy on “wash transactions.”
Contact us for more information and to get started with our tax professionals.