When designing or negotiating a securitization structure, while commercial and non-sales tax issues may take precedence, GST/HST issues should be at the forefront of the structuring discussions in order to avoid tax leakage as a result of sales tax exposure.
GST/HST – basic overview
GST/HST is charged on each taxable supply made in Canada. One of the first steps in a GST/HST analysis is to identify the different supplies being made in a particular transaction. This generally involves listing all of the different elements of a transaction, determining whether one or more elements may be considered part of a single supply, and then identifying the main or dominant element. If there are multiple supplies, but one is incidental to another and they are provided together for a single consideration, the incidental supplies may be deemed to form a single supply together with the “main” supply.
Once each supply is identified, generally the next step is to determine the characterization of the supply and whether it is taxable or exempt. If a supply is taxable (and not zero‑rated), GST/HST is charged. The tax rate depends on the province in which the supply is made and ranges from 5% to 15%. There are specific rules that deem in which province a supply is made. If the supply is exempt, then the supply is not considered to be a “taxable supply,” resulting in no GST/HST.
The supply of a “financial service” is generally an exempt supply. The supply of some financial‑related products or services is obviously a supply of a financial service. However, others are less clear and have not been specifically considered by the Canada Revenue Agency. For example, a right to be paid money is a debt security, the sale of which is exempt, but a contingent right to be paid money is not a debt security, in which case the sale of that contingent right would be taxable. Further, while the agreeing to provide, or arranging for, an otherwise financial service is an exempt supply, there are many exceptions. A service that falls outside this “arranging for” description, or that falls into one of the exceptions, is taxable.
Generally, GST/HST payable by a business in the course of its “commercial activities,” as defined in the legislation, can be recovered by claiming an input tax credit (“ITC”). To the extent a business is engaged in making exempt supplies, the business is not engaged in “commercial activities” and cannot recover the GST/HST payable for property or services it acquires for those activities.
The identification and characterization of supplies made in financial‑related arrangements has been the subject of recent tax litigation and is very fact specific.
If the entity is making taxable supplies and is exclusively engaged in commercial activities, then that entity should be eligible to recover any GST/HST payable, provided the other conditions for claiming an ITC are met, such as obtaining the required documentary evidence. However, issues may arise when the entity is not engaged exclusively in commercial activities.
Generally, an ITC can only be claimed to the extent to which a registrant (i.e., a person that is registered for GST/HST or that is required to be so registered) acquired or imported the property or service for consumption, use or supply in the course of commercial activities of the person. Where a participant within the securitization structure is not engaged in a commercial activity, the participant may not have the ability to recover GST/HST paid or payable.
For example, if there are taxable administrative services being performed for an entity that is engaged exclusively in non‑commercial activities, that entity will not be able to recover the GST/HST payable, thereby increasing the costs of operation. The magnitude of cost will depend on whether the rate being charged is 5%, 13% or 15%. In addition, where QST applies, 9.975% QST may be charged in addition to the 5% GST. Generally, QST applies similarly to GST/HST but there may be some nuances.
Seek GST/HST advice from the beginning
To mitigate against unnecessarily increasing operating costs within a securitization structure, it is important to engage a GST/HST advisor early. Once negotiations are well underway, or the structure is designed (and possibly implemented), the parties may be very reluctant to change course. If GST/HST matters are considered from the beginning, potential cost issues can be addressed throughout the process, benefitting all parties involved.
Editor Note: The efficient and effective analysis and structuring of the tax treatment and characterisation of structured finance and securitization transactions can have critical consequences for the timely and successful implementation of such deals. The Miller Thomson Tax team works closely with our colleagues within the Firm’s Structured Finance and Securitization group on all aspects of the structuring, documentation, and execution of a diverse range of alternative and specialized finance transactions. Our Tax team will regularly consider and report on hot topics and key tax considerations relevant to structured finance transactions within this newsletter.
If you have concerns about your securitization structure, reach out to a member of Miller Thomson’s Sales, Commodity and Indirect Tax or Structured Finance and Securitization team.