Overview of Section 186 of the ETA

History and purpose

Following a series of amendments that came into force on July 27, 2018 and May 17, 2019, a new version of section 186 of the Excise Tax Act (ETA) emerged.

The amendments were intended to limit the broad scope that the courts had given the provision, notably in Canada v. Stantec Inc., 2009 FCA 285, and Miedzi Copper Corporation v. The Queen, 2015 TCC 26.

The former wording of subsection 186(1) deemed a parent to have acquired certain property and services in the course of its commercial activities and therefore allowed it to claim an input tax credit (ITC) where the property or service could reasonably be regarded as having been acquired for consumption or use in relation to shares of the capital stock or indebtedness of another corporation.

The new subsection 186(1) limits and specifically identifies the situations in which a parent may claim an ITC relating to units or indebtedness of another corporation. The amendments also broaden the provision by allowing corporations, partnerships and trusts to qualify as a “parent”.

Section 186 is intended to allow a person — a corporation, partnership or trust — to claim ITCs on expenses relating to units or indebtedness of a related corporation, or of a corporation directly or indirectly controlled in the case of a partnership, that carries on commercial activities.

Definitions and deeming rules

The concepts of an “operating corporation” (Opco) and a “unit” are central to the provision.

An Opco is a corporation related to the parent, or directly or indirectly controlled by it where the parent is a partnership, all or substantially all of whose property was acquired for consumption, use or supply exclusively in the course of its commercial activities. The parent may be a corporation, partnership or trust.

In substance, an Opco is a corporation engaged in commercial activities to which a property-use test applies. This point is discussed further in the section addressing the Canada Revenue Agency’s (CRA) published position.

Subsection 186(0.1) defines a “unit” as a share of the capital stock of a corporation, an interest in a partnership or a unit of a trust.

The parent’s right to claim ITCs — subsection 186(1)

The former section 186 had been considered in several court decisions that gave a broad interpretation to the circumstances in which a corporation holding shares of another corporation could claim an ITC.

Subsection 186(1) now enumerates the applicable conditions and strictly defines the situations giving rise to an ITC. The activities described in the provision are deemed to be carried on in the course of the parent’s commercial activities, allowing it to claim an ITC when it incurs certain expenses relating to an Opco. The ordinary ITC rules continue to apply to its other activities.

A parent may claim an ITC relating to the acquisition, importation or bringing into a participating province of property or a service if:

• it is a corporation, partnership or trust;
• it is resident in Canada;
• it is registered for GST/HST purposes;
• a particular corporation is an Opco of the parent;
• one of the situations in paragraphs 186(1)(a) through (c) applies.

Paragraph 186(1)(a)

The first qualifying situation is where the parent acquires property or a service for the purpose of selling or otherwise disposing of, or purchasing or obtaining, units or indebtedness of an Opco.

The second is where the parent acquires property or a service to enable the Opco to redeem, issue, convert or otherwise modify units or its own indebtedness.

Paragraph 186(1)(b)

The third situation is where the parent acquires property or a service to obtain financing for itself and then uses that financing to fund the Opco, to the extent that the financing is used in the Opco’s commercial activities.

The property or service must be used to issue or sell units or indebtedness of the parent, and the proceeds must be transferred to the Opco. The funding must take the form of a loan of money or the purchase or other acquisition of units or indebtedness from the Opco.

Only the portion used to finance the Opco’s commercial activities gives rise to an ITC. For example, the loan shown in Figure 2 could finance equipment that the Opco will use primarily in the course of its commercial activities.

Paragraph 186(1)(c)

The fourth situation allows the parent to claim an ITC to the extent that property or a service is acquired, imported or brought into a participating province for the purpose of carrying on an activity of the parent, provided that all or substantially all — administratively, at least 90% — of the parent’s property consists of:

• property that it manufactured, produced, acquired or imported for consumption, use or supply exclusively in the course of its commercial activities, with the meaning of “exclusively” varying according to whether the parent is a financial institution;
• property that consists of units or indebtedness of the parent’s Opcos;
• a combination of such property.

The parent must therefore satisfy a “property-use test”. A parent that holds property used exclusively in its commercial activities, only shares of an Opco, or a combination of the two may qualify for an ITC. Paragraph 186(1)(c) is, however, subject to significant exceptions.

First exception — subparagraph 186(1)(c)(i)

A parent cannot claim an ITC to the extent that the property or service was acquired, imported or brought into a participating province to carry on an activity that relates primarily — administratively, more than 50% — to units or indebtedness of a person other than the parent or one of its Opcos. This could include services relating to transactions in shares of a public corporation that does not qualify as an Opco.

A contrario, a parent that satisfies the property test may claim ITCs on property or services acquired to carry on an activity that relates primarily to its own units or indebtedness or those of an Opco.

The wording therefore appears to open the door to recovery of tax paid by a parent holding only shares of an Opco on accounting expenses or rent. Such a parent, if it makes no other supplies, has no activity other than holding the Opco shares, so the exclusion involving another person would not apply.

It will be interesting to see how tax authorities interpret this provision. The concept of property or a service acquired “for the purpose of carrying on an activity” is new to the ETA. Does the mere holding of shares constitute an “activity” for purposes of paragraph 186(1)(c)? Unlike subparagraph 186(1)(c)(ii), subparagraph 186(1)(c)(i) does not appear to require the parent to make a supply.

Second exception — subparagraph 186(1)(c)(ii)

Even where a parent meets the property test, it cannot claim an ITC to the extent that the property or service was acquired, imported or brought into a participating province to carry on an activity in the course of making an exempt supply. An exception applies where the activity is one of the financial services expressly listed in the subparagraph and relates to units or indebtedness of the parent or an Opco.

Although the opening words of paragraph 186(1)(c) suggest that, to the extent the parent meets the “property-use test”, it should be entitled to claim the ITC, the cascade of exceptions in fact limits its scope to two situations.

The first is where the parent carries on an activity, otherwise than in the course of making a supply, that relates primarily to units or indebtedness of a person that is the parent or an Opco of the parent.

And the second is where the parent makes a supply of financial services that are expressly listed in relation to its own units or indebtedness or those of the Opco.

CRA position

The CRA has had few opportunities to elaborate on its position concerning the amendments to section 186.

In a ruling published in April 2022, 233442 — GST/HST Ruling — Input Tax Credit Eligibility for […] [X], the CRA considered the “property-use test” in subsection 186(0.2), as it applies to an Opco, and in paragraph 186(1)(c), as it applies to the parent.

The CRA concluded that a person holding bank accounts worth more than 10% of the total value of its property did not satisfy the property-use test. In that ruling, the result excluded the parent from paragraph 186(1)(c).

The underlying reasoning is that money deposited in a bank account is a debt security and therefore a financial instrument under subsection 123(1). A bank account is consequently “property” that must be included in the test. In contrast, because the definition of property excludes “money”, an amount held in a form that qualifies as money under the ETA would not contaminate the person’s property-use test.

The result may appear unusual, although it follows the statutory definitions. Parliament may eventually consider excluding certain financial instruments from the test to avoid this result while ensuring that the person carries on exclusively commercial activities.

Cascading treatment — subsection 186(3)

Subsection 186(3) allows Opco status to be extended through a corporate chain. A holding corporation that owns only shares and indebtedness of an Opco may therefore itself qualify as an Opco.

If the shares and indebtedness of an Opco are deemed to be property used in the course of a person’s commercial activities, that person may satisfy the Opco test in subsection 186(0.2).

This cascading treatment is available only through an uninterrupted chain of corporations holding shares of another corporation. Opco status cannot pass through a partnership or trust.

Conclusion

At first glance, the new section 186 is considerably clearer and less ambiguous than its predecessor. It precisely identifies the situations in which it can apply, which should reduce the risk of disagreement with tax authorities.

Nevertheless, tax professionals, taxpayers and tax authorities still have limited experience applying the provision. At the time of publication, only one CRA interpretation letter addressing the new section 186 had been identified. Prudence remains advisable, as does close attention to the latest interpretations issued by the tax authorities.