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Completing the HST puzzle for investment plans and starting anew for others


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Canadian Indirect Tax News – 17 February, 2011 (11-1)

A PDF version of this Newsletter can be downloaded below.

On January 28, 2011, the Department of Finance (Finance) released an updated package of proposed tax rules for mutual funds, segregated funds, pension plans, and other types of investment plans, collectively referred to herein as investment plans (IPs).[1] The rules deal with how an IP determines its PVAT liability. PVAT is the provincial component of the Harmonized Sales Tax (HST) for each participating province (PP) – i.e., the provinces that have harmonized their sales taxes with the federal Goods and Services Tax (GST).[2] To date, New Brunswick, Newfoundland, Nova Scotia, British Columbia and Ontario have harmonized.

By way of reminder, with Ontario and British Columbia joining on July 1, 2010, the HST rules for IPs underwent a major overhaul to accommodate different HST rates among the PPs (i.e., HST at 12%, 13%, and 15%) and the fact that not all provinces have harmonized (i.e., GST at 5%). As a result, many IPs became selected listed financial institutions (SLFI). This means that they have to use a special formula to determine their PVAT liability. The bulk of the proposals set out rules as to how the formula should be applied, particularly the appropriate attribution percentage for each PP. Non-SLFIs are also impacted by the proposed rules.

The most recent package, released on January 28, 2011, is comprised of draft regulations (Draft Regulations), which update:

  • The draft regulations released by Finance on June 30, 2010
  • Draft legislation (Draft Legislation) to implement certain proposals requiring amendments to the Excise Tax Act (ETA), and
  • A backgrounder (January 28th BG). This is the third backgrounder released by Finance on this topic. Finance released its first backgrounder on the proposed rules on May 19, 2010 (May 19th BG) and another one on June 30, 2010 (June 30th BG).[3]

With respect to IPs, many of the changes and announcements included in the package are the outcome of industry consultations and pretty well now complete the puzzle as to how IPs need to account for and comply with the HST. Key changes and announcements are summarized in Table 1 below.[4] They fall into five categories:

  • Anti-avoidance
  • Provincial attribution percentages (PAP)
  • Pension entities
  • Non-SLFIs
  • Compliance

We encourage readers to review the Draft Regulations and Draft Legislation carefully and to consult their advisors as appropriate. There have been many changes since the last draft regulations released on June 30, 2010, some of which are significant, in our view. The January 28th BG provides a good general summary of the changes but it does not capture all of the changes and nuances that may be important for a particular IP.

With some exceptions the rules came into effect on July 1, 2010. Although they are being administered by the Canada Revenue Agency (CRA), these draft rules are not yet law.

While the HST puzzle for IPs is now complete, a new puzzle for other Investment vehicles or scenarios is beginning to be assembled. These other vehicles/scenarios are not included in the current proposals to date but are under review by Finance as announced in the January 28th BG. They include:

  • Investment trusts and partnerships with investors in more than one province
  • Trusts holding assets of pension entities that are SLFIs
  • De minimisFIs with a significant level of investment activity, and
  • Trusts governed by a registered retirement saving plan, a registered retirement income fund or a registered education savings plan administered on a group rather than individual basis

The purpose of such a review is to ensure equity will exist with other investment vehicles, such as IPs, in the application of HST.

Finally, Finance also announced that it will be reviewing the rules to determine the PVAT liability of an SLFI IP in respect of taxable inputs that relate to the activities of the IP where the inputs are acquired by a third party. Such a review will deal with ensuring that PVAT is properly applied to these inputs considering the corresponding activities to which they relate.

The Government has invited comments on the proposals and review areas by March 31, 2011.

To provide a further update for SLFIs with respect to these and other announcements and releases by the government over the past few months, we include:

  • Table 2, which summarizes many of the various forms in connection with the proposals that the CRA has released to date
  • Table 3, which summarizes some of the forms for SLFIs in connection with the proposals that have not yet been released

Table 1: Key changes and announcements from the January 28th BG

Issue Description Comments Effective date
Anti-avoidance rules      
Specified investors

In order for an SLFI IP to calculate its PAP, the difficulty lies with the identification of PAPs for its institutional investors (i.e., non-individual) investors. Where such investors are considered to be “specified investors”, no look-through is required and that investor’s PAP is 100% in the province where it has its business residence/address. One of the tests for determining whether an investor is a specified investor is that the investor invests less than $10 million in an investee plan.

Any investor that is a non-distributed investment plan requiring look-through is now defined as a “qualifying investor”. The draft rules now put greater onus on an investor in self-identifying to an SLFI IP that they invest in (investee plan) as being a qualifying investor and thus, to provide the appropriate PAP information on its investors or members to the investee plan. This would occur, for example, where an investor is related to another investor and together they invest $10 million or more in an investee plan, but individually each investor has less than $10 million invested in the investee plan.

Qualifying investors are now required to self-identify and report to the investee plan, including IPs that do not distribute to the public but are SLFIs, such as pension plan trusts, benefit plan trusts, retirement compensation arrangement trusts and deferred profit sharing plan trusts. They will be subject to penalties for failure to provide information as required.

If an investor does not inform an investee plan of its status as required, then the investee plan treats the investor as a specified investor. However, the rules as currently drafted put the onus back onto the investee plan if it “knows, or ought to know” of the status of the investor based on information available to it.

Applies in respect of any reporting period of an investee plan that ends on or after July 1, 2010.
Attribution point planning The units acquired in a “specified transaction” from a DIP (or series in a DIP) that uses the preceding year method (with or without reconciliation) to determine its PAP for a PP are assigned the highest PVAT rate. A specified transaction generally refers to the acquisition of units of the DIP (series) where the acquisition occurs less than 31 days before the attribution point, the units are sold within 30 days after the attribution point, the value satisfies a 10%/$10,000,000 de minimis test, the DIP’s (series’) PAP is less than it would have otherwise been had the transaction not occurred, and the transaction is not undertaken in good faith as part of normal business practice by arm’s-length parties on arm’s-length terms.

Addresses concerns by Finance that DIPs (or series in a DIP) may intentionally structure sales to investors to achieve a more beneficial PAP. It appears that the rule may have limited application to commercial arm’s-length transactions.

The specific threshold test is quite intricate (to tracing PAP variances) and subjective (based on “good faith” test).

Applies in respect of a reporting period that ends or after July 1, 2010.
PAP      
Treatment of non-residents

As proposed initially in the June 30th BG, non-resident investors or members of IPs would be deemed to be residents of Canada for purposes of determining an SLFI IP’s PAP. This has the effect of minimizing the attribution percentage to the PPs. However, it was proposed that no input tax credits (ITC) would be permitted in respect of GST paid on costs associated with the making of taxable supplies to the non-resident investors. It was proposed that an IP could elect to not follow this deemed resident rule.

The January 28th BG tables the Draft Legislation that deals with the initial proposals from the June 30th BG. However, further restrictions and obligations are imposed on IPs that do not elect out of the deemed resident rule, such as:

  • Generally, not being entitled to an ITC in respect of an input unless the input is used directly and exclusively in commercial activities of the IP, and
  • Outlays and expenses incurred in respect of the non-residents deemed to be Canadian residents would be deemed to be in respect of Canadian activities of the IP and thus subject to the GST self-assessment rules for imported supplies

The election to opt out of the deemed resident rule can be made on a series-by-series basis with some further restrictions on the claiming of ITCs in respect of inputs that relate in part to a series for which an election was not made.

The costs and benefits of filing the election are not intuitive. These further restrictions and obligations need to be considered carefully by impacted IPs in determining whether or not to elect out of the deemed resident rule.

Applies in respect of any fiscal year that ends on or after July 1, 2010.

Merger of existing IPs or series

 

PAP calculation rules for IPs that merge have been further clarified. Where a merged IP uses the preceding year method (i.e., the default method) or the current method with reconciliation (election required) to determine the PAP with a September 30th attribution date, the applicable rule would depend on whether the merger occurs before, or on or after September 30th.

  • If the merger occurs before September 30th, the PAP determined on the day of the merger would be used for the transitional year only (i.e., until December 31st of the year of the merger).
  • If the merger occurs on or after September 30th, the PAP determined as of the day of the merger would be used for the rest of the transitional year and the subsequent fiscal year.

The rules do not apply where the PAP is determined using the real time method. Special rules/modifications are proposed for exchange-traded funds.

The merger rules are still only limited to combinations of IPs and IP series. Other types of “mergers” are not addressed. Applies in respect of any reporting period that ends on or after July 1, 2010.
New IPs or series

As a result of industry consultation, a new default method called the reconciliation method is proposed. A new IPs/series may estimate its PAP and calculate the net tax from the initial distribution date to one of two possible attribution dates:

  • The 90th day after the initial distribution date, or
  • The last day of the month that includes the 90th day noted above

The actual PAP is determined on the chosen attribution date (above) and a true-up to the actual is done for the period that the estimate is used. If the IP’s (series’) first attribution date after the initial distribution is before September 30:

  • Use the PAP determined on that date up until December 31 in that transitional year, and
  • Use a new PAP calculated as of September 30 in the transitional year for the following year

No look-through is required in the transitional year. Look-through is required in the following year.

If the IP’s (series’) first attribution date after the initial distribution is on or after September 30, use the PAP determined on that date for the remainder of the transitional year and the following year. No look-through is required for either year.

Provides clearer compliance rules for the default case and an alternative to the gross-up alternatives initially proposed. Applies in respect of any reporting period that ends on or after July 1, 2010.

Exchange traded funds

 

An exchange traded fund may apply to the CRA for pre-approval of its PAP for a PP instead of using the default. An exchange traded fund is not required to look-through its institutional investors for the provincial attribution investor percentage.  This is in recognition of the fact that exchange traded funds may have limited investor information compared to other DIPs. Applies in respect of any fiscal year that ends on or after July 1, 2010.
Real time method An IP that elects to use the real-time method to determine its PAP for each PP may determine the PAP on the first business day (or such other day that the Minister may allow on application) of each quarter, month or week, as well as on a daily basis. The attribution point is no longer restricted to the first day of each month or daily. Provides more flexibility. Applies in respect of a reporting period that ends on or after July 1, 2010.
Pension entities      
Qualifying small investment plans (QSIPs)

Non-DIPs are not subject to the SLFI rules for a fiscal year if they are QSIPs where they have unrecoverable GST ((A-B) in the SAM formula) in their immediately preceding fiscal year of less than $10,000 and have not elected to be treated as an SLFI for the fiscal year.

For pension entities, the unrecoverable GST would also include GST on deemed supplies made by a participating employer of the pension plan.

The impact is that the $10,000 threshold may not be reached until later, after the GST on deemed supplies is included. Applies for a fiscal year beginning after January 28, 2011 (the announcement date).
PVAT rebates A qualifying pension entity is entitled to a 33% rebate of the GST/HST it has actually paid and GST/HST deemed to have been paid. Where the pension entity is an SLFI, the federal component of the rebate is claimed through a rebate application. The Draft Regulations establish that the provincial component of the rebate is provided for under the SAM formula and the rebate in respect of GST payable by the pension entity (i.e., federal component of the rebates) is deducted when determining the pension entity’s PVAT liability. The draft regulations released on June 30, 2010 did not address the mechanism for the pension entity to obtain the rebate. The revised Draft Regulations now include this rebate calculation. Applies in respect of a reporting period that ends on or after July 1, 2010.
Non-SLFIs      
Relief for non-DIPs with  all or substantially all members in non-PPs

Non-DIPs with:

  • 10% or less of its members, and
  • less than $100 million of asset value (or actuarial liability value for defined benefit pension plan)

in HST provinces, are not subject to the SLFI rules (SAM formula, etc.) and instead follow the normal self-assessment and rebate provisions applicable to FIs.

No such relieving rule exists for the converse scenario; i.e., where 90% or more of the members are in one HST province. Applies to reporting periods ending after July 1, 2010.
Relief for provincial IPs The non-SLFI status afforded to IP series distributed and held in only one province (announced in June 2010), will be extended to non-stratified IPs (i.e., those not divided into series). As a result, these plans (as well as the series previously addressed) will follow the normal self-assessment and rebate provisions applicable to FIs. Logical extension of earlier announcement to provide parity between single province series or plans. Applies to reporting periods ending after July 1, 2010.
Broader rebate for IPs in respect of investors in non-PPs The rebate available to non-SLFI IPs currently limited to the PVAT paid for services of the manager/administrator is extended to PVAT payable on all goods and services acquired by the IP. Addresses long-standing inequity. Applies to rebates for tax that became payable or was paid without becoming payable on or after July 1, 2010.
Extension of self-assessment for provincial IPs and series Provincial plans and series will be specifically included in the PVAT self-assessment requirements given their exclusion from SLFI treatment. Provides greater legislative clarity. Applies to reporting periods ending after July 1, 2010.
Compliance      
Consolidated filing election Per the draft regulations released by Finance on June 30, 2010, new IPs created in a particular year could not be added to an existing consolidated group for that year because the new fund would not have the same fiscal year as the funds in the existing consolidated group. The IPs had to wait for the following year to be added. The amended Draft Regulations remove the same fiscal year requirement and permit the addition of new IPs to the consolidated group for the year in which they were created.

Should minimize administrative complexity and provide flexibility of the initial rules.

 

Applies in respect of a reporting period that ends on or after July 1, 2010. Effective July 1, 2010.
Relief from filing annual information return (AIR) for FIs IPs required to file the GST 494 (SLFI return) are exempted from current requirement generally applicable to all registrant FIs with annual revenue over $1 million to file the AIR (GST 111). Reduces compliance. Applies to fiscal years ending on or after July 1, 2010.
LFI permitted to revoke filing frequency election LFIs that had filed elections for monthly or quarterly reporting are permitted to revoke that election and return to the default annual reporting period. Simplifies compliance. Applies to fiscal years commencing after December 31, 2010.

Table 2: Forms released by CRA

Form number Title
RC4601 GST/HST Reporting Entity and Tax Adjustment Transfer Elections and Revocations for a Selected Listed Financial Institution
RC4602 Request for a Group GST/HST Registration Number for Selected Listed Financial Institutions with Consolidated Filing
RC4603 GST/HST Adjustment Transfer Election and Revocation for a Selected Listed Financial Institution
RC4604 GST/HST Reporting Entity, Consolidated Filing and Tax Adjustment Transfer Elections and Revocations for a Selected Listed Financial Institution
RC4605 Total Tax Recovery Rate Election and Revocation for a Selected Listed Financial Institution
RC4606 Election or Revocation for a Qualifying Small Investment Plan to be Treated as a Selected Listed Financial Institution
RC4607 GST/HST Pension Entity Rebate Application and Election
RC4610 Election and Revocation of an Election to Exclude Non-Resident Investment Holdings from the Calculation of the Provincial Attribution Percentages
RC4612 Application to Not be Considered a Selected Listed Financial Institution

Table 3: Pending release by the CRA

Title Description
Attribution points election To have quarterly, monthly, weekly, or daily attribution points.
Real time attribution method election To calculate the PAP using current year values.
Preceding year method with reconciliation election To calculate the PAP using current year values. Reconciliation for current year on final SLFI return.
Gross-up method for a new IP election To calculate the PAP for a new IP for the first and second year.
Modified real time method for a new IP election To calculate the PAP for a new IP for the first year.
Transitional year election (July 1, 2010 to December 31, 2010) To simplify the calculation of a DIP’s (other than exchange traded funds) PAP for the transitional period.
Exchange traded funds application Application for approval of PAP method.
Additions/deletions to group registration Additions/deletions to a group registration for the consolidated filing election.
Revocation of monthly or quarterly filing To allow LFIs to revoke an election made to be monthly or quarterly filers.
GST 494 Form Return for SLFI to calculate PVAT liability; expected no earlier than the end of February 2011.

[1] See http://www.fin.gc.ca/n11/11-009-eng.asp for the package of documents.
[2] PVAT stands for Provincial Value Added Tax.
[3] See http://www.fin.gc.ca/n10/10-062-eng.asp for Finance’s release on June 30, 2010 for the June 30th BG and the initial draft regulations. See http://www.fin.gc.ca/n10/data/10-050_1-eng.asp for the May 19th BG.
[4] Note some additional defined terms used in Table 1: Qualifying small investment plan (QSIP) and Distributed investment plan (DIP).

 

 

This publication is produced by Deloitte & Touche LLP as an information service to clients and friends of the firm, and is not intended to substitute for competent professional advice. No action should be initiated without consulting your professional advisors. Your use of this document is at your own risk.