Choose Wisely: Problems with GST/HST Real Estate Joint Venture Election
This is the third in a series of posts on the Goods and Services Tax/Harmonized Sales Tax (“GST/HST”) and real estate. Prior posts covered: the rules for collection of GST/HST on real estate, bare trusts, and GST/HST new housing rebates and investment real estate.
The focus of this article is on joint ventures, a structure commonly used for real estate development. Recently, the Canada Revenue Agency has increased its audits of joint ventures due to a change in how it interprets and administers the GST/HST rules.
Joint ventures are not separate persons for GST/HST purposes, unlike partnerships which can account for tax and claim ITCs at the partnership level. However, section 273 of the ETA allows participants in joint ventures for certain activities (including real estate development) to elect to appoint an operator to account for GST/HST on all aspects of the joint venture. The operator would have the ability to collect and remit GST/HST pertaining to the joint venture, as well as pay GST/HST and claim any associated ITCs. The designation of a party as an operator has the effect of concentrating the GST/HST responsibilities on the operator thereby freeing up the other parties from such responsibilities. Absent this election, the individual participants would be required to account pro rata for their share of the joint venture supplies and would claim a share of any ITCs.
The designation of the operator of a joint venture has been under scrutiny since late-2014. Pursuant to section 273, the operator must be a participant in the joint venture. The CRA has a long-standing position on the meaning of participants in a joint venture, as articulated in Policy Statement P-106 (“Administrative Definition of a ‘Participant’ in a Joint Venture”). The CRA notes that a participant in a joint venture means either a person who makes an investment in the joint venture and takes a proportionate share of revenue (i.e., has a financial interest) or a person who is responsible for the managerial and operational control of the joint venture. A nominal financial interest is usually sufficient if a person is to be a participant based on financial interest. Alternatively, managerial and operational control requires the operator to have the actual ability to manage the joint venture. According to the CRA, such control includes actual authority to manage the joint venture’s daily activities without needing the input or approval of other parties.
Until the beginning of 2015, the position of the CRA with respect to operators of joint ventures was that it would accept an entity’s designation as an operator without financial or managerial control. However, the administrative tolerance in this regard ended as of 2015 such that an operator must meet the administrative definition of participant in order to be deemed to be a participant in the joint venture. Nevertheless, parties engaged in joint ventures continue to designate operators without allocating managerial and operational control or a financial interest.
Joint venture participants have traditionally disregarded or been unaware of the CRA’s administrative position on operators of joint ventures. Operators have traditionally neither been given a financial interest nor given operational or managerial control. The CRA has correspondingly accepted and ignored joint venture participants disregarding its administrative position on operators. However, the CRA noted in late 2014 that it would be implementing its administrative position commencing 2015. As such, an operator of a joint venture would be required to have a financial interest or managerial and operational control to be validly designated as an operator.
Notwithstanding the CRA’s withdrawal of the administrative tolerance on this issue, many joint venture participants continue to disregard the administrative position. Operators are being designated without any financial interest or managerial or operational control. This poses a significant risk for joint venture participants. If an entity is not accepted as a valid operator on audit, the participants of the joint venture will each technically be non-compliant in collection and remittance obligations as each participant will be required to account for its share of the tax pertaining to the joint venture. Additionally, the operator will have claimed ITCs that it may not be entitled to claim – and it may now be too late for the proper person to claim those ITCs. Therefore, the implications of an invalid operator designation can be significant.
Simon Thang, LL.B, LL.M (Taxation) is Toronto tax lawyer practising exclusively in the areas of Canadian sales tax (GST/HST, PST), and customs and trade. He is the principal of Thang Tax Law.