GST/HST and Professional Fees

Introduction

Professional fees can be substantial in a corporate reorganization. At first glance, it may seem advantageous to have the professionals’ fees paid by a GST/HST-registered entity within the corporate group so that it can claim input tax credits (ITCs). This practice can, however, be risky and may even increase the actual cost of the professional fees by 14.975% (in Quebec).

General principles

Subsection 169(1) of the Excise Tax Act (ETA) provides that a person’s ITC:

is claimed for a reporting period during which the person is a registrant;
relates to property or a service of which the person is the recipient;
corresponds to the tax that became payable or was paid during the reporting period; and
is available to the extent that the person acquired the property or service for consumption, use or supply in the course of its commercial activities.

In short, to qualify for an ITC, the registered recipient of a taxable supply must acquire it for use in the course of its own commercial activities.

Recipient, registration and commercial activity

The definition of “recipient” is fundamental to ITC eligibility. Subsection 123(1) of the ETA generally identifies the recipient as the person liable to pay the consideration for a supply. The agreement for professional services should therefore identify the person that will claim the ITC as the recipient of the services and the person liable to pay the fees. Tax authorities should deny recovery by any other person, since only the recipient of a supply is entitled to the related ITC.

The recipient must also be a registrant when the tax is paid or becomes payable. Registration must therefore be planned at the appropriate time for the person that will receive a taxable supply, including when new corporations, partnerships or trusts are created. A voluntary registration generally cannot be backdated by more than 30 days before the application is submitted. An earlier effective date may be accepted in certain circumstances where the person was required to be registered. It nevertheless remains preferable to plan registration in advance of a reorganization.

Finally, the recipient must have acquired the supply for consumption, use or supply in the course of its own commercial activities. The definition of “commercial activity” in subsection 123(1) of the ETA includes, among other things, a business carried on by a person, except to the extent to which the business involves the making of exempt supplies by the person.

Subsection 141.01(2) of the ETA further provides that, when a person acquires a supply for consumption or use in the course of an endeavour, the person is deemed to acquire it for consumption or use in the course of commercial activities to the extent that it is acquired for the purpose of making a taxable supply for consideration in the course of that endeavour.

According to the Canada Revenue Agency (CRA) in GST/HST Memorandum 8.3, Calculating Input Tax Credits, a recipient of professional services determining its ITC eligibility must:

determine its intention at the time it acquired the supply;
determine the extent to which it acquired the service to make taxable supplies and for other purposes; and
determine the tax status of the first-order supplies it makes and for which the service was acquired.

The CRA states:

Where inputs are acquired, imported or brought into a participating province for consumption or use for the purpose of making a particular supply (the first-order supply), and the first-order supply is made for the purpose of making another supply (the secondary supply), it is the tax status of the first-order supply that determines whether the inputs are for consumption or use in a commercial activity.

In other words, the professional service must be linked to a specific taxable supply made by the recipient, which is a fairly restrictive interpretation. This is a question of fact that must be considered in light of all relevant circumstances. It should also be noted that the courts have adopted a considerably more liberal approach than the CRA.

Special cases

The legislation provides certain exceptions to the general rules described above. Briefly, subsection 185(1) of the ETA allows a registrant that acquires property or a service for consumption, use or supply in the course of making supplies of financial services related to the registrant’s commercial activities to claim the related ITC.

For example, the CRA has confirmed that this provision allows a corporation formed to acquire and operate commercial real property, and that offers shares to finance its activities, to claim an ITC for legal fees relating to the offering and issuance of those shares, even though those transactions are exempt supplies of financial services.

Subsection 186(1) of the ETA sets out circumstances in which a registered corporation, partnership or trust acting as a holding entity may claim ITCs on expenses relating to shares or debt of a related corporation engaged in commercial activities. Several conditions relating to share ownership and the use of the related corporations’ property must be met before the ITC is available. For more on this subject, see Overview of Section 186 of the ETA, Stratège (2023), vol. 28, no. 2, p. 26.

Conclusion