Keeping abreast of tax changes is never easy at the best of times, so INHOUSE canvassed leading tax practitioners, asking them for the top-five pitfalls that can trip companies up and draw unwanted attention from the tax man.
Shifting tax rules are always a vexing element of doing business. Here are five recent changes you and your company’s dealmakers should know about.
The GST/HST Registry:
Following in the footsteps of Québec with its Québec Sales Tax registry, Ottawa has set up a registry to keep track of those registered under the goods and services tax and the harmonized sales tax registrants. (In Nova Scotia, New Brunswick, and Newfoundland and Labrador, the provincial sales tax is “harmonized” with the GST.)
This will help your company when it is entering a purchase and sale agreement, says Robin MacKnight, tax lawyer and partner with Wilson Vukelich LLP in Markham, Ont. In the past, there have been instances when “rogues provided bogus GST numbers,” says MacKnight. That left purchasers out of pocket — thousands or even millions of dollars — unable to recover GST they paid in a deal, when attempting to obtain GST input credits.
Even if you checked with the Canada Revenue Agency (CRA), says MacKnight, officials might confirm a number is valid, but they wouldn’t tell you if it is connected to the vendor. “The CRA seems to be tightening enforcement on GST input credits,” says John Brussa, partner and tax lawyer with Burnet Duckworth & Palmer LLP in Calgary. To prevent your company from getting caught in the CRA’s enforcement web, due diligence must be done.
Purchasers can now verify whether a vendor is GST-registered, says David Robertson, partner and commodity tax lawyer in the Toronto office of Fasken Martineau DuMoulin LLP. It’s also good practice for your accounts payable department to check GST numbers on invoices, especially when they’re from new suppliers, says Robertson.
In addition, notes Robertson, the registry will also assist in conducting commercial real estate deals. Generally, it’s the purchaser’s responsibility to self-assess and remit GST if they’re registered for GST. Robertson cautions, however, that vendors should still do due diligence to make sure the purchaser is GST-registered by checking the number given to them by the purchaser. To confirm GST numbers go to: www.cra-arc.gc.ca/eservices/tax/business/gsthstregistry/menu-e.html
Post-sale consulting contracts:
It’s not uncommon for the purchase and sale of a business to be facilitated by including a “consulting contract” for the former owner.
A consulting arrangement is attractive for the purchaser because an income deduction can be obtained for part of the purchase price. Otherwise, by purchasing the shares of the business, the vendor is paying for capital, which doesn’t provide a deduction. And the deduction for “goodwill” is minimal, adds MacKnight — just seven per cent of 75 per cent of the purchase price.
However, the CRA is now keeping a close eye on consulting contracts. “The vendor really has to provide consulting services,” says MacKnight, “or the deduction will be denied. No more ‘wink, wink.’” The agency is following the Foresbec decision made in the Tax Court of Canada in 2002, he adds.
This is perfectly reasonable if there is no intention for the vendor to consult, says William Bies, partner and corporate tax lawyer with Fasken Martineau DuMoulin LLP in Toronto. If consulting is undertaken, adds Bies, the CRA will look for “reasonable” payments for those services.
So, forget about doing a $2-million deal where $500,000 is put aside for consulting. “The agreement must reflect the real economics underlying the deal,” says Brussa. “The CRA is taking a very aggressive view on what constitutes a ‘misleading statement.’ You can’t call a dog a cat, even if you have a contract that calls it a cat.”
In the past, payment for a non-competition clause has been seen as a windfall for the vendor and, therefore, taxable. But vendors have been successful in challenging the taxability of non-compete payments, says Bies.
The most notable decision was Manrell v. Canada, made by the Federal Court of Appeal in 2003, when the court decided that such payments should not be taxable to the vendor. Subsequently, the federal Finance Department released proposed amendments that will effectively overturn this decision. However, the amendments haven’t been finalized.
Meanwhile, corporate counsel should advise their dealmakers that a non-compete clause should be considered non-taxable when they’re negotiating purchase and sale agreements. In other words, vendors should charge extra. A payment for non-competition should be factored in up-front, says Brussa. “You want a paper trail that reflects the payment as one for non-competition.”
Withholding tax on payments to non-resident suppliers:
Say your company has installed new operational software purchased from a U.S. company. You pay a U.S. trainer to help your employees learn the new system. Under the Income Tax Act’s regulation 105, 15 per cent of the payment for the trainer must be withheld and remitted to Ottawa. That amount can usually be recouped under the foreign tax credit provisions of the Canada-U.S. Income Tax Treaty — if a Canadian tax return is filed.
One option for avoiding this process is to obtain an s. 105 waiver. However, doing so is “not a slam dunk,” says MacKnight. The CRA will question whether the American company has a permanent establishment in Canada and should, therefore, be subject to Canadian tax on business income earned here.
Meanwhile, says MacKnight, obtaining the waiver can eat up as much as $5,000 in legal fees. But if the waiver is not obtained, the Canadian company will be on the hook for the tax, plus any penalties and interest for any tax that hasn’t been remitted.
The CRA has aggressively been going after Canadian payors in this area,” says Bies.
“When in doubt, withhold,” recommends Brussa. “The supplier can still resort to the treaty. You’re not prejudicing the supplier — just protecting your company.”
Due to the cost involved, it is suggested the Canadian company notify the American supplier that it should obtain the s. 105 waiver — before the training contract begins. Otherwise, tax will be withheld.
Clearance certificates for non-resident share redemptions:
When a non-resident disposes of taxable Canadian property, including shares, the purchaser must obtain an
s. 116 clearance certificate or withhold a portion of the gross purchase price and remit it to the CRA.
If your company, as the purchaser, is assessed and found not to have withheld the tax, it will be liable for penalties and interest on top of the tax. This applies even if it can be argued that the non-resident was not liable for tax, says Brussa.
“The withholding rules are becoming more stringent.” But, he explains, that’s because the CRA wants to prevent Canadian companies from making payments to non-residents who could just slip away without paying tax.