As we transition to the third quarter in a year unlike any experienced by this generation of Private Equity (PE) leaders, management of Canadian portfolio companies and PE sponsors are looking beyond tax relief measures. Instead, they are undertaking a deeper analysis of spending activities of both PE firms and portfolio companies to identify possible areas of savings.
Improving cash flow while maintaining an essential supply of goods and services for operating a business is a delicate balance and one that PE firms are applauded for doing well. An often-overlooked area of savings is sales tax and specifically, Goods & Services Tax/Harmonized Sales Tax (GST/HST) and Quebec Sales Tax (QST). Portfolio companies registered for these taxes often deem them as “in-and-out” on the books, but may be surprised to learn of the significant savings for businesses that undertake a detailed review of these accounts. PE firms themselves may also be eligible for certain sales tax recoveries depending on their structure. However, they must be careful that all conditions are met, as outlined below. The following four opportunities could be valuable to those seeking additional dollars in the wake of COVID-19.
Recaptured input tax credits
Recaptured input tax credits (RITCs) are a source of great confusion for even the most sophisticated businesses. In Ontario and British Columbia, RITCs were introduced in 2010 following the harmonization of GST with each province’s provincial sales tax (PST) to create the 13% and 12% HST, respectively (prior to BC withdrawing from the HST regime and resuming the imposition of a PST). It generally applied to businesses with greater than $10m annual taxable supplies and certain specified financial institutions. It required businesses having to repay the provincial portion of the HST (as much as 8 points) on purchases of specified properties and services including:
- qualifying motor vehicles, certain vehicle parts and services, and in Ontario, motive fuel (other than diesel fuel) for use in motor vehicles
- specified energy
- specified telecommunication services
- specified meals and entertainment
In Ontario, the program was phased out over several years and ceased on June 30, 2018. However, legacy issues continue to create issues for businesses that made errors or continue to recapture input tax credits (ITCs) when it is no longer required in certain provinces. Similar opportunities exist in PEI and Quebec as they continue to impose restrictions on ITCs and QST input tax refunds (ITRs), respectively, until 2021.
The overpayment of GST/HST in this regard has reached the hundreds of thousands of dollars for some businesses. If you believe an error was made in calculating RITCs, the eligibility to correct those errors is expiring soon as there is a four-year statute of limitations.
Travel & Entertainment (T&E) expenses
Accurately capturing ITCs and ITRs related to T&E is another common oversight. A complex exercise for many PE firms and portfolio companies, missed refunds on these seemingly small amounts of tax add up. Some taxpayers that have not invested in diligent accounting for the tax component of these purchases have experienced recoveries in the tens of thousands of dollars. To simplify the process, CRA released GST/HST Policy P-184R. This policy provides a simplified method for employees, partnership members, and volunteers (where certain conditions are met) to recover tax on credit card purchases by allowing the use of rate factors to impute the tax paid. Beware of some common traps such as imputing tax on unreasonable expenses, such as flat rate mileage claims that are typically a taxable benefit to employees.
Cash flow relief opportunity for related parties
Using elections between related businesses is another opportunity for cash flow relief. The election allows otherwise taxable supplies to be made between related parties without transacting GST/HST and QST.
Intercompany transactions can be significant and the relief enjoyed by related parties that correctly elect to transact for “nil consideration” for GST/HST and QST purposes frees up considerable amounts of cash for PE firms to use for other purposes. Where Canadian resident incorporated businesses or eligible partnerships meet the conditions, they must file a RC4616 election with CRA in this regard. PE firms undertaking this opportunity are urged to check with their tax advisors to confirm they are eligible for this election. Incorrectly using the election may result in the assessment of interest and penalties for unsuspecting taxpayers.
Parent company relief opportunity
Savvy tax accountants will tell you that a business not engaged in a “commercial activity” is typically not eligible to claim ITCs and ITRs in respect of the GST/HST and QST incurred, and in many situations they would be right. On the surface, this would appear to eliminate the eligibility for a holding company that exists only to hold the shares of an operating company from being registered for and claiming recoveries of GST/HST and QST. However, section 186 of the Excise Tax Act provides relief to corporations residing in Canada that hold shares or indebtedness of a related corporation and use 90% or more of its property exclusively in commercial activities (e.g., an operating company) where the tax incurred relates to the holding or administering of the shares or indebtedness. This provision allows eligible holding companies to recover potentially large amounts of GST/HST incurred in the course of their activities.
Draft legislation released in May 2019 will result in changes to the application of section 186 effective July 28, 2018. The changes have yet to receive Royal Assent; when it does come into force it may limit the ITCs (and ITRs due to QST harmonization) holding companies are eligible for.
Many PE firms and portfolio companies face a myriad of challenges and PE leaders find themselves navigating unchartered waters as this new business environment unfolds. BDO Canada’s national indirect tax team and larger tax services group is available to help identify relief and cash flow saving ideas along with our colleagues that support businesses in the Private Equity sector. Please contact us to discuss how you can take advantage of these ideas to improve cash flow and identify savings.
Brian Morcombe, Partner, Indirect Tax
Jamie Windle, Partner, National Private Equity Leader
Rose Cross, Partner, International Tax