Written by: Darryl Rankin

If your business is involved in any revenue-sharing arrangements, it is crucial to be clear in which direction the money and the Canada GST/HST (Goods and Services Tax and Harmonized Sales Tax) “supply” are legally flowing.

The tax consequences can be vastly different depending on the direction, especially if one party is making “exempt” supplies (such as health care, financial services, educational services, or residential rent).

For example, suppose a doctor working at an Ontario medical clinic shares revenue with the clinic on a 60-40 basis. For every dollar paid by the provincial health plan, 60% goes to the doctor and 40% goes to the clinic. And suppose there is $100,000 of such revenue in a given period.

Is the clinic paying the doctor $60,000 to provide medical services to the clinic’s patients?

Or is the doctor paying the clinic $40,000 for use of the clinic’s facilities?

Or are the two in partnership to provide medical services?

Or is this a joint venture to share the revenues?

The GST/HST consequences will be very different in each scenario.

Let’s consider the first two options:

  • If the clinic is paying the doctor for medical services, that is an exempt health care supply, and no HST applies. But it also means the clinic can’t claim input tax credits (ITCs) for the HST it pays on rent, equipment, medical supplies, and office costs.
  • If the doctor is paying the clinic for the use of its facilities, that is taxable rent, and the clinic must charge the doctor 13% HST on the $40,000 (i.e., $5,200). But then the clinic can claim ITCs to recover all the HST it pays on its costs.

Which one is “preferable” depends on your point of view and the circumstances. But both arrangements involve significant audit risk if the business does not get it right.

If situation (a) applies, the clinic should not charge the doctor HST. But it also must not claim ITCs, whether or not it charges HST. If it charges the doctor HST and claims ITCs, and the CRA concludes that situation (a) applies, then:

  • The doctor has overpaid HST that wasn’t payable, and steps need to be taken to reverse this so the doctor can recover the HST from either the clinic or the CRA. Otherwise, the doctor is out of pocket $5,200 unnecessarily.
  • The clinic must remit to the CRA the HST it billed to (or collected from) the doctor, even if the HST wasn’t payable, unless it takes special action to refund the HST using a “credit note” that meets certain conditions.
  • The CRA will assess the clinic to deny the ITCs the clinic claimed, and will assess interest (and, in some cases, penalties).

Conversely, if situation (b) applies, and the clinic has not been charging HST to the doctor, the CRA will assess the clinic for the HST not charged and remitted, plus interest and possibly penalties (including late-filing penalties if the clinic wasn’t filing GST/HST returns at all).

So either way, you have to be sure which way the money is legally flowing.

How do you determine this? The CRA, and the Courts, will look at the contracts between the parties, the invoicing, the legal right to act, and the actual facts.

First, the contract must make it clear what the parties’ intentions are. We sometimes see clients who have set up a contract — perhaps drafted by their lawyer, but the lawyer was not a GST/HST specialist — that is internally inconsistent. It should be crystal clear from the contract whether the clinic is supplying facilities to the doctor (who is providing services to the patients), or the doctor is providing medical services to the clinic (which is providing services to the patients).

Second, the invoicing or payment documents must be consistent with the intention. If situation (a) applies, the clinic should be reporting, on the document accompanying payment to the doctor, that it is paying the doctor $X for medical services. If situation (b) applies, the clinic should be issuing an invoice to the doctor for its fees, plus HST; and if the clinic collects the payments up front, any payment record from the clinic should show that it is remitting moneys it collected as the doctor’s agent, and deducting this fee from the amount it is paying the doctor.

Third, CRA will wish to see that there is a legal right for each party to do what it is doing. For example, if it appears that the clinic is practicing medicine and the governing provincial legislation does not allow this, the CRA may say that this cannot be happening. This is actually incorrect: there is extensive case law that says parties are taxed on what they do, whether or not what they do is legal. However, convincing a CRA auditor of this is sometimes challenging, so it is preferable to set up a structure that is legally valid under all governing laws and regulations (this is also advisable for non-tax purposes, of course, so as not to run into trouble with a governing body such as the provincial College of Physicians).

Finally, the CRA auditor will look at the actual facts of the relationship between the parties. If the contract and the invoicing claim there is a particular structure or direction of payment, but the “facts on the ground” show that is not actually what is happening, the CRA may reject the documentation as being a sham or “window dressing”.

So it is very important to get the structure right. This issue has arisen in several Court cases, including the 1524994 Ontario, West Windsor Urgent Care, and Middleton cases (Federal Court of Appeal and Tax Court of Canada).

This issue of “revenue sharing —which direction?”  also occurs in other situations besides health care services. Some of these have been the subject of appeals in the Courts. For example:

  • A bank and a store cooperate to place automated teller machines (ATMs) in the store. The bank and the store shared the revenues. Is the bank earning the revenues and paying the store to rent space for its machines? Or is the store earning the revenues and paying the bank to provide exempt financial services (Mac’s Convenience and River Cree Resort cases)? The same question came up for laundry machines placed in apartment buildings (Phelps Appliances case).
  • A massage parlor had masseuses who provided “non-therapeutic” massages. Were the masseuses providing services directly to customers and paying the massage parlor a fee, or was the massage parlor charging the customers and paying the masseuses from its revenues (Manship Holdings case)?
  • A travel agency and a tour planner shared their revenues from selling tour packages. Who was providing services to whom (in the Pauwels case, the two were found to be in partnership —so the answer was “neither one”)?

Similar issues can arise in cases that don’t involve revenue sharing. For example:

  • Landowner X hires builder Y to build a home on X’s land. But they sign a contract that says Y is selling X a new home. Is Y providing services to X, or is Y selling X a home? The GST/HST consequences can differ (Anand case).

As you can see, it is important to make sure that one’s contracts match the invoicing, and match the reality of what is being done, so as not to run into serious GST/HST problems and CRA assessments.

This newsletter content should be used for general informational purposes only and not as a substitute for consultation with professional tax, legal, or other competent advisors. Before making any decision or taking any action based upon the information contained on this website, you should consult with a DMA professional.

If you need further information about anything in the newsletter, please get in touch with your DMA advisor, and we will be pleased to assist you. If you are not a current DMA client, please click here to contact us.