Input Tax Credit for Holding Corporation: Subsection 186(1)
Section 186 of the Excise Tax Act (“ETA”) allows a Canadian holding corporation to claim input tax credits for GST/HST paid on property or services that it acquired or imported for use or consumption in relation to shares, or debt, of a related corporation (i.e., a subsidiary). Without this provision, no ITCs would normally be available to a holding corporation in such cases because of the exempt nature of activities related to ownership of shares and holding of debt. Section 186 in effect deems that such activities are for commercial use of the holding company and, therefore, entitled to ITCs.
Here is a simple example:
HoldCo is a Canadian resident corporation and registered for GST/HST. HoldCo does not make taxable supplies and most of its activities relate to its ownership of shares and investments, which are generally exempt activities that do not generate input tax credits. OpCo is a wholly owned subsidiary of HoldCo. OpCo is a Canadian corporation that is fully engaged in manufacturing chocolate products from its factory in Ontario. It makes taxable supplies of chocolate to its customers in Canada and abroad.
HoldCo received an offer from a competitor to purchase HoldCo’s share in OpCo for $15M. HoldCo retained legal and accounting professionals to assist in reviewing the offer and incurred $25,000 in HST on professional fees.
Result: HoldCo could fully recover the $25,000 in HST that it paid on professional fees by claiming ITCs. This is an easy example where the expense was incurred in relation to shares in a related corporation pursuant to subsection 186(1).
CRA focused on Holding Company’ ITCs
Over the past year or so, the CRA has been increasingly focusing its audit activities on holding companies and corporate groups that have claimed ITCs under section 186. These audits follow the November 2011 release of Memorandum 8.6, Input Tax Credits for Holding Companies and Corporate Takeovers which outlined the CRA’s interpretation of s. 186. The memorandum provides a number of examples that highlight the CRA’s position on when ITCs would and would not be available. The CRA continues to take a narrow view on claims under section 186 despite recent case law that favours a broader interpretation.
This article will provide a review of subsection 186(1) and the requirements for a holding company to claim ITCs, together with an update on the CRA’s administrative position and recent case law.
Key elements to subsection 186(1)
Section 186 is the principal provision that allows a holding company to claim ITCs. To qualify under subsection 186(1), there are four basic requirements which will be discussed, below, in some detail. Where these requirements are met, the shares or indebtedness of the related corporation held by the holding company are deemed to be property of the holding company and used by it exclusively in the course of a commercial activity. Accordingly, the holding company can claim an ITC for GST/HST paid on property or services that are acquired or imported by it to the extent it is used in relation to the shares or indebtedness.
Holding company must be a GST/HST registrant and corporation resident in Canada.
A registrant includes a person that is registered for GST/HST or required to be registered. There are two ways that a Canadian resident corporation can voluntarily register, and meet this requirement, under paragraph 240(3)(d):
a) it owns shares or hold indebtedness of a related corporation; or
b) it is acquiring or proposes to acquire all or substantially all of the shares of another corporation.
And, importantly, all or substantially all of the property of the related or other corporation must have last be acquired or imported or use in the course of its commercial activities.
The other corporation must be “related” to the holding company.
Two corporations are related if they meet the requirements under subsection 126(2) of the ETA, which simply refers the reader to subsections 251(2) to (6) of the Income Tax Act (Canada). In short, it is a control test. Where the holding corporation controls the subsidiary (i.e., more than 50% ownership of shares) they are related.
All or substantially all of the related corporation’s property must have been acquired or imported by it for consumption, use, or supply exclusively in the course of its commercial activities.
Property Use Test
The “property use test” is a fundamental requirement in the GST/HST system because it is the commercial activities of the subsidiary that permits ITCs to be claimed by the holding company. In other words, all or substantially all (i.e., 90% or more) of the subsidiary’s property must be used in making taxable supplies (whether taxable or zero rated) rather than exempt supplies (e.g., financial services). Where less than 90% of the subsidiaries property is used or consumed in commercial activities, subsection 186(1) would not be available.
The character of the subsidiary’s supplies is fundamental to the property use test; in other words, the question becomes whether the subsidiary is fully engaged in providing taxable or exempt supplies. In a recent decision of the Tax Court of Canada in Pay Link Financial Corporation v. The Queen the Minister disallowed ITCs claimed by a holding company by operation of subsection 186(1) for various expenses related to a wholly owned subsidiary. The Minister argued that the subsidiary did not meet the property test because it was making exempt supplies of financial services in the normal course of its operations, and not commercial activities (i.e., taxable activities). The taxpayer argued that the subsidiary was supplying taxable computer services, and did meet the property test. The TCC dismissed the taxpayer’s appeal and held that the subsidiary was making exempt supplies of financial services and, therefore, the holding company did not meet the property test and could not claim ITCs.
Holding company can claim ITCs to the extent that it acquired or imported the particular property or service for consumption or use “in relation” to the shares or indebtedness of the related corporation.
Much of the grey area that exists between CRA interpretation and industry practice can be traced to whether GST/HST was paid on property or services that were used or consumed in relation to shares or debt of a subsidiary. The CRA’s view is that GST/HST incurred by the holding company must be directly tied its ownership of shares or debt, and should not be “one step removed” from that direct connection. This point was addressed by the Tax Court of Canada in Stantec v. The Queen , where the Minister advanced the one step removed argument to disallow ITCs claimed by a holding company (i.e., Stantec) under section 186. In Stantec, the taxpayer claimed ITCs for GST/HST paid on advisory services to raise capital to purchase the shares of a US corporation which was to merge with Stantec’s US subsidiary. The Minister’s primary concern was that the advisory services were in relation to raising capital in Stantec’s own shares, and not the shares of its subsidiary. The distinction was, in the Minister’s view, one step remove, or not direct enough, to be “in relation to” a share of a related corporation under paragraph 186(1)(b).
The Tax Court of Canada disagreed with the Minister’s position and adopted a broader interpretation of subsection 186(1), stating: “…the connection need not be one of a primary nor substantial nor directly related nature. The concept of “in relation to” is not one of prominence let alone exclusivity.” The Tax Court rejected the one-step removed doctrine that was advanced by the Minister.
Further support for this position was discussed in Perfection Dairy Group (2008 TCC 342), where the holding company incurred legal fees to instigate a legal action on behalf of a subsidiary that was in bankruptcy. The Court held that the legal expenses were reasonably regarded as having been incurred in relation to the shares and, if successful, would result in an additional value in shares of subsidiary.
CRA maintains a narrow interpretation of section 186
The CRA’s interpretation of section186 can be found in Memorandum 8.6, as discussed, and Policy Statement P-196R. Despite the decisions in Stantec and Perfection Dairy Group, the CRA’s interpretation of section 186 has been unaltered. The CRA is adamant that taxpayer’s do not claim ITCs where those costs are one step removed from its ownership of shares or debt in a related corporation. By way of example, the CRA cites that a holding corporation would not qualify for ITCs under subsection 186(1) in relation to a subsidiary if it raises capital by issuing its own shares or borrowing money (see Example 2 in Memorandum 8.6), contrary to the Tax Court’s approval in Stantec.
For a list of examples that address the purpose test under section 186, please refer to Memorandum 8.6 which includes claims for legal, accounting, appraisal, and other professional fees, as well as costs of holding a shareholder’s meeting.
Privately held companies will often have holding companies within their corporate group. From a GST/HST perspective, it is important to monitor the activities of each subsidiary when making claims under section 186. As discussed above, there are four main requirements that must be met to claim ITCs. Changes in the activities or ownership of the subsidiaries should raise a flag to a tax practitioner to review for implications under GST/HST.
Timing of Test
It is important to note that the requirements in subsection 186(1) must be met each time the holding company receives a supply for which it wants to make a claim for ITCs. It is at that time and at the time that payment of GST/HST was paid or become payable that the test must be met.
Again, it would be prudent to monitor activities within a corporate group on a consistent basis to ensure that the holding company claiming ITCs continues to qualify under subsection 186(1). Has there been any change in ownership in a subsidiary? Has there been any change in the business operations of a subsidiary away from taxable supplies (e.g., investments)? And, of course, what is the purpose of the supply in relation to the holding company’s shares in a related corporation? Only a few questions to keep in mind when considering ITCs claims under subsection 186(1).
Written by Bobby B. Solhi, J.D., HST lawyer in Toronto.
 R.S.C., 1985, c. E-15.
 Section 186(3) could be used to look down a chain of corporations to claim ITCs in relation to shares of debt of a subsidiary that is fully engaged in commercial activities.
 (2012 TCC 203).
 (2008 TCC 400); affirmed at Federal Court of Appeal (2009 FCA 285).
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