Nature of the Election

To streamline their GST/HST compliance and improve their GST/HST cash flow, two "closely related" GST/HST registrants can relieve GST/HST on taxable transactions between them by entering into a joint election (the "Election") pursuant to subsection 156(2) of the Excise Tax Act (the "ETA"). In addition to the benefits of the Election for ongoing transactions, the Election can be useful to improve cash flow in the context of reorganizations or "one-off" transactions with significant dollar values.

The Election is generally available between two parties that are:1

(a) GST/HST registrants,

(b) engaged exclusively in taxable commercial activities,

(c) corporations resident in Canada or "Canadian partnerships"2 or a combination of each, and

(d) "closely related" for GST/HST purposes.

To determine whether two corporations are closely related, the criteria in section 128 of the ETA should be considered.3 As a straight-forward example, where a parent corporation owns not less than 90% of the value and number of the issued and outstanding shares of the capital stock of another corporation, having full voting rights under all circumstances, the two corporations are closely related.

To determine whether two Canadian partnerships, or one such partnership and a corporation, are closely related to each other, the detailed rules in subsection 156(1.1) of the ETA should be consulted. If, in the example above, a Canadian partnership were substituted for the parent corporation, then the partnership and corporation would be closely related.

To determine whether a registrant is engaged exclusively in a commercial activity under the existing rules in effect until January 1, 2015, a registrant must satisfy one of the two following tests (the "Commercial Activity Test"):

a) all or substantially all4 of the registrant's property (other than financial instruments) was acquired (or manufactured, produced or imported into Canada) for consumption, use or supply exclusively for use in the registrant's commercial activity, or

b) if the registrant has no property (other than financial instruments), all or substantially all5 of the supplies previously made by the registrant were taxable supplies.

In practice, due to the restrictiveness of the Commercial Activity Test, a newly formed partnership or corporation ("Newco"), without any history of making supplies and without any property,6 is restricted from entering into the Election with a closely-related supplier and thereby from obtaining GST/HST relief on the taxable acquisition of business assets from the supplier.7 This restriction denies access to the Election in circumstances where it would appear to be appropriate to allow the Election (i.e., to relieve the GST/HST compliance and cash flow burden for closely related registrants, to the extent that they engage in taxable transactions between them, where doing so would not result in any tax loss to the government).

To overcome this restriction and satisfy the Commercial Activity Test, parties have used a two-step planning technique (the "Two-Step Technique"). In the initial step, Newco would acquire an asset of nominal value and pay GST/HST (recoverable by input tax credit ("ITC") claim) on the nominal value. Once this initial transaction is completed, the closely-related supplier could then transfer assets to Newco under the Election without GST/HST applying.

Amendments to Take Effect on January 1, 2015

To respond to these concerns about the limitations on the availability of the Election, the federal government announced amendments in its February 2014 budget (the "Amendments") to change the criteria for qualifying for the Election effective January 1, 2015. The amendments became law on June 19, 2014.8

By adding "forward-looking" criteria to the Commercial Activity Test, the Amendments are intended to allow Newco to access the Election without using the Two-Step Technique. Newco would satisfy these criteria if it were reasonable to expect that:

a) Newco will make taxable supplies throughout the next 12 months,

b) all or substantially all9 of those supplies will be taxable supplies, and

c) all or substantially all10 of the property (other than financial instruments and property having nominal value) to be manufactured, produced, acquired or imported by Newco within the next 12 months will be for consumption, use or supply exclusively in the course of Newco's commercial activities.

While elements of the prior Commercial Activity Test are preserved by the Amendments, the Two-Step Technique will no longer be available for Newco to qualify for the Election. Assets of nominal value will be specifically excluded from consideration under the Commercial Activity Test.

As of January 1, 2015, closely related persons entering into the Election will be required to file the jointly completed and signed prescribed Election form with Canada Revenue Agency ("CRA"). Formerly, the Election form had to be maintained on file for audit purposes, but not actually filed with CRA.11

In addition, the Amendments introduce joint and several liabilities for the parties to an Election, or purported Election.12

Concerns Arising From the Amendments

While the intention of the Amendments - to permit Newco to make the Election without resort to the Two-Step Technique - is commendable, and other changes may improve (at least from the CRA's perspective) the administration of the Election, they, nevertheless, raise a number of concerns.

There remains considerable uncertainty regarding the proper interpretation of the new "forward-looking" Commercial Activity Test. Could it exclude a start-up business or a business in an initial research and development phase? Such a business might not have any taxable supplies during its first 12 months. What is meant by the requirement that Newco make taxable supplies throughout the first 12 months? Could the election be denied if Newco sells all its business assets within the first 12 months? Would it be sufficient for Newco to make taxable supplies at any time during the next 12 months (e.g., in the 12th month)? Unfortunately, at this time it is not clear how CRA intends to address these questions.

By excluding property of "nominal value" from the Commercial Activity Test, the Amendments leave open the issue of how "nominal value" will be interpreted and applied by CRA. Will nominal value be interpreted in absolute or relative terms? That is, if Newco initially has a $20,000 asset, but will subsequently acquire business assets with a value of $1 million, would the $20,000 asset be considered to have nominal value?

This uncertainty could increase the risk of CRA disallowing GST/HST relief claimed under an Election for an acquisition of assets by Newco. If CRA disagrees with parties relying on an Election made, or purported to be made, to relieve GST/HST, then, in view of the Amendments to impose joint and several liabilities against the parties, CRA could assess either or both of the parties for the uncharged and unremitted GST/HST, plus any applicable interest and penalties.13

There are new filing requirements for the Election. If these requirements are not met after 2014, then the Election would be invalidated and CRA could assess either or both parties for uncharged, uncollected and unremitted GST/HST, plus any applicable interest and penalties.14

Practical Tips - Addressing Concerns with the Amendments

Given the uncertainty and limitations of the "forward-looking" test, Newco could be worse off under the Amendments than under the existing rules. The Amendments eliminate the ability to implement the Two-Step Technique discussed above to access the Election. Where Newco is acquiring business assets from a closely related supplier, consider whether a variation of the Two-Step Technique (the "Planning Technique Variation") could be utilized to access the Election on the transfer of the assets (or at least most of the assets).

Under the Planning Technique Variation, to qualify for the Election, Newco could acquire property of greater than nominal value, pay GST/HST (recoverable by ITC claim) on that preliminary acquisition (whether from the closely related supplier or a third party) and subsequently acquire any property from the closely related supplier GST/HST-free under the Election. Again, if what constitutes nominal value were measured in relative terms, then the Planning Technique Variation could be problematic, particularly in view of the exposure to joint and several liabilities under the Amendments.

Given these concerns and limitations, another consideration to be borne in mind is that the joint election on the sale of a business or part of a business under section 167 of the ETA could be available to obtain GST/HST relief on the transfer of business assets to Newco from a closely related supplier. Nevertheless, if Newco and the closely related supplier were to have ongoing transactions between them, consideration could be given to entering into the Election to relieve those transactions from GST/HST.

A sale of real property is excluded from the application of a closely related Election jointly made under subsection 156(2) of the ETA.15 However, the same GST/HST cash flow relief as under the Election could be achieved by the vendor being relieved from charging and collecting the GST/HST on the taxable sale of the real property and the purchaser having to self-assess GST/HST and claiming an offsetting ITC on the same return.16

Finally, as of January 1, 2015, jointly completed and signed Election forms will have to be filed with CRA on a timely basis to be valid. Parties to an existing Election in place before January 1, 2015 will have to file the jointly completed and signed Election form in 2015.17 Even if the Election form had been filed before January 1, 2015, the Election form would have to be filed again.18


1 Definitions of "qualifying member" and "qualifying group" in subsection 156(1) of the ETA.

2 The definition of "Canadian partnership" is in subsection 156(1) of the ETA. Each partner of a Canadian partnership is either a corporation or partnership resident in Canada.

3 Paragraph (a) of the definition of "qualifying group" in subsection 156(1) of the ETA.

4 CRA has administratively interpreted "all or substantially all" to mean at least 90%, although the jurisprudence suggests a lesser proportion could suffice, depending on the particular circumstances. See, for example, Ruhl (W.) v. Canada [1998] G.S.T.C. 4 (TCC).

5 Ibid.

6 Other than financial instruments within the meaning of subsection 123(1) of the ETA.

7 Does not satisfy paragraph (c) of the definition of "qualifying member" in subsection 156(1) of the ETA in effect until January 1, 2015.

8 S.C. 2014, c. 20, (Bill C-31, Royal Assent June 19, 2014), section 40.

9 Supra, footnote 4.

10 Ibid.

11 ETA, ss. 156(2) and (4)(b).

12 ETA, subsection 156(5). CRA can cancel or waive interest in excess of 4% of the uncollected taxes pursuant to CRA's GST/HST Memorandum 16-3-1 – Reduction of Penalty and Interest in Wash Transaction Situations.

13 Ibid.

14 Ibid.

15 ETA, paragraph 156(2.1)(a).

16 ETA, subsections 169(1) and (4), 221(2), and 228(4) and (6).

17 ETA, ss. 156(2) and (4)(b).

18 ETA, subsection 156(2.01).

The foregoing provides only an overview and does not constitute legal advice. Readers are cautioned against making any decisions based on this material alone. Rather, specific legal advice should be obtained.

© McMillan LLP 2014