Introduction

Most tax and accounting professionals understand that financial services are exempt for GST/HST and QST purposes. Some are familiar with the idea that financial institutions (FIs) have a special status with respect to their GST/HST and QST obligations. Few are comfortable with the intricate rules and criteria used to determine whether a particular entity qualifies as an FI, a listed financial institution (LFI) or a selected listed financial institution (SLFI) for GST/HST and QST purposes.

It is therefore not uncommon to discover after the fact that an entity is - and has been for several years - a financial institution. Often associated with this discovery is the realization that the entity is delinquent in its filing obligations and sometimes has a sizeable GST/HST and/or QST liability that cannot be ignored.

While the purpose of this article is not to review all possible unforeseen situations involving FIs, LFIs and SLFIs, we will review two examples of entities that could qualify as financial institutions while staying under the radar of most professionals acting in good faith. The first one, which is a relatively recent addition to the family of FIs, is the investment limited partnership (ILP). The second one is the de minimis FI.

Investment Limited Partnerships

In December 2018, the second 2018 Budget bill enacted new rules relating to ILPs which took effect on September 8, 2017, when they were originally announced. These amendments were implemented to level the playing field with similar entities that were already regarded as investment plans by the Excise Tax Act (ETA) and thus subject to the SLFI rules. Prior to the amendments, investment entities structured as limited partnerships could avoid the burdensome and complex compliance requirements applicable to LFIs and SLFIs. They could also avoid paying certain taxes related to management and administrative services, as such services could be deemed not to have been acquired by the partnership under the legislation as applicable before September 8, 2017.

What is an Investment Limited Partnership?

Some authors have commented that the ILP definition is potentially intractable. Although the language used in the legislation may be ambiguous, in practice there are straightforward cases. An ILP is a limited partnership:

  • whose primary purpose is to invest funds in property consisting primarily of financial instruments, if the limited partnership is, or forms part of an arrangement or structure that is, represented or promoted as a hedge fund, investment limited partnership, mutual fund, private equity fund, venture capital fund or other similar collective investment vehicle; or
  • whose primary purpose is to invest funds in property consisting primarily of financial instruments, if the total value of all interests in the limited partnership held by LFIs is 50% or more of the total value of all interests in the limited partnership.

In practice, any time prima facie LFIs - banks, credit unions, mutual fund trusts and similar entities - use a limited partnership as an investment vehicle, it is likely that the limited partnership itself will qualify as an FI for Canadian sales tax purposes. Consequently, it is wise to explore and assess this possibility as soon as a suspicious organizational chart appears.

When a limited partnership qualifies as an ILP, there are two main consequences. On the one hand, under subsection 272.1(8) of the ETA, if a general partner of the ILP supplies administrative or management services to the ILP:

  1. the rendering of the service is deemed not to be done by the general partner as a member of the ILP; and
  2. the supply by the general partner to the ILP that includes the service is deemed to have been made otherwise than in the course of the ILP’s activities.

In other words, where a general partner renders management services to the ILP, the general partner is deemed to have made a supply in the course of its own activities, which ultimately makes this deemed supply taxable. In some contexts, this provision may even deem parts of distributions made by the ILP under the limited partnership agreement as having been made in respect of administrative or management services provided by the general partner and, accordingly, as taxable supplies.

On the other hand, an ILP qualifies as an investment plan pursuant to paragraph 149(5)(f.1) of the ETA, which makes the ILP an LFI. In and of itself, an ILP’s status as an LFI means that it may be required to file the Financial Institution GST/HST Annual Information Return, subject to subsection 273.2(2) of the ETA. However, an ILP that is an SLFI may be excluded from the reporting-institution requirement applicable to that annual information return under section 6 of the Financial Services and Financial Institutions (GST/HST) Regulations.

An ILP could also qualify as an SLFI if it has a permanent establishment in a participating province and in another province. In practice, if the ILP’s partners reside in different provinces, the ILP may be an SLFI. This determination of residence and permanent establishments is also subject to a myriad of highly technical and complex rules, including specific deeming rules for investment plans.

Qualifying as an SLFI brings burdensome compliance obligations. It also involves a potential annual adjustment to the net tax of the ILP, from which may arise a sales tax liability that accrues with each year that the ILP is not compliant.

But it may also bring opportunity, since some SLFIs may reasonably expect a negative adjustment to their net tax by virtue of their presence in an advantageous combination of different provinces.

De Minimis Financial Institutions

What is a De Minimis Financial Institution?

De minimis FIs could be seen as residual FIs. They are FIs that are not listed by name in paragraph 149(1)(a) of the ETA and that qualify by virtue of the nature of their revenue streams. In general, under paragraph 149(1)(b) of the ETA, a person whose financial revenue represents more than 10% of total revenue for the year and is greater than $10 million is a de minimis FI.

In this context, the financial revenue of a person is the total of interest, dividends and fees charged for financial services earned by the person. It excludes, under subsection 149(4) of the ETA, interest and dividends from a related corporation.

Even if a de minimis FI cannot be an SLFI, it is nonetheless subject to specific compliance requirements like other FIs. One of the crucial issues with de minimis FIs is cases where such entities are operating entities that make financial revenues that are ancillary to their main taxable commercial activity. In this context, the qualification of the person as an FI has major consequences, including being subject to special rules for apportioning or allocating input tax credits and input tax refunds of FIs. In such cases, a review of the activities of entities regarded as FIs and of the organizational structure can be indicated.

Conclusion

It is not always self-evident that entities qualify as FIs in the legislative framework of Canadian sales tax. However, tax professionals should remain vigilant to that possibility. Some flags should be raised whenever recognizable financial institutions make an investment through another entity, such as a limited partnership, or when financial revenues become a substantial part of a person’s business. ILPs and de minimis FIs are only two of many different types of FIs, each type having its own specificities. A prudent approach in this area is advisable, as the traps and pitfalls abound.