Section 156 Election: GST/HST Between a Holdco and Opco

Does a holding company have to charge GST/HST on management fees or rent to its operating company?

A holding company that bills its operating company for management fees or commercial rent generally makes a taxable supply. Unless it is a small supplier, it must register and charge GST/HST (Excise Tax Act, section 240; CRA). Two companies that qualify can instead file a section 156 election, so no GST/HST is charged between them. Both must be registrants (registered, or required to register), and both keep filing returns. A holding company that only holds shares and bills no one makes no taxable supply, so there is nothing to charge or elect.

These things make a case not simple:

• The small-supplier limit of $30,000 counts the holding company's associates, so the operating company's taxable sales count too. A small fee does not by itself keep a holding company under the limit.
• The election needs a corporate ownership chain of at least 90%. Two companies owned side by side by the same individual do not qualify.
• The election does not cover a fee the operating company does not use exclusively in commercial activities, such as in exempt work. "Commercial activities" means business carried on to make taxable sales, zero-rated ones included; exempt sales are not part of them. It is hard to start late, and both companies answer for unpaid tax while it runs.
• Invoices have already gone out. If no valid election was in effect, the supplies were taxable in the usual way, whether or not tax was charged. Registration, past returns and credit claims need checking before anything is filed.

Gather before deciding: the share register, voting rights and any shareholder agreements or options of both companies; each company's GST/HST number, filing frequency and filed returns; the operating company's taxable and exempt sales; the fee or rent agreement; and every invoice since billing began.

Does the holding company need its own GST/HST number, and do the operating company's sales count toward the small-supplier limit?

A holding company needs a GST/HST number once it makes taxable supplies and is no longer a small supplier. The operating company's taxable sales count toward the $30,000 limit when the two companies are associated (section 148).

Corporations are associated for GST/HST when they are associated for income tax, which turns on control and other tests in the Income Tax Act. A person who controls the holding company, and a partnership or trust that person controls, is also its associate. Association is tested at the start of each calendar quarter (section 127; Income Tax Act, section 256; CRA, RC4022).

The test counts taxable sales, zero-rated sales included, of the holding company and each associate, including the owner's own sole-proprietor business. Exempt supplies, financial services and sales of capital property are left out.

A holding company below the limit may register voluntarily if it makes taxable supplies (CRA). The election needs both companies to be registrants: required to register, or actually registered voluntarily (CRA Memorandum 14-5). A company that makes only exempt supplies generally cannot register. For the full test and the dates, see do you need to register for GST/HST.

What does the section 156 election do?

The election treats taxable supplies between the two companies, while it is in effect, as made for no consideration (the CRA calls this nil consideration), so no GST/HST is payable on them, apart from the exclusions below (section 156(2); CRA Memorandum 14-5).

• Both directions. A fee billed down to the operating company and rent billed up to the holding company are both covered.
• Joint and optional. Both companies make it together on one form. Neither has to make it.
• GST/HST only. It is made under the federal Excise Tax Act and does not settle QST or PST, which this page does not cover. It does not decide whether a fee is reasonable or deductible. See management fees between a holdco and opco.
• When it matters. If the operating company sells only taxable goods or services, it claims the tax back as a credit, so the election mainly saves cash flow and paperwork. The real cost appears when it cannot claim the tax in full, for example with exempt sales.
• Credits on other costs stay. The election does not change either company's right to input tax credits on its own costs (CRA Memorandum 14-5).

Which companies qualify for the closely related election?

Two companies qualify when each is a Canadian-resident corporation (a parent outside Canada cannot join) and a registrant, the two are closely related, and each passes a property or supply test (section 156(1)). Closely related is a stricter test than associated.

If the same individual owns both companies directly, the election is not available; two qualifying subsidiaries of the same corporate parent can qualify. When the election is not available, the holding company charges GST/HST if it is a registrant, and the operating company claims credits as usual. Whether to change the ownership is a corporate tax decision, not a filing step.

Special voting rights or separate class votes that a statute gives shareholders on certain matters are left out of the voting-control test (section 128(1.1)). A share does not count as owned if someone who is not closely related to the owner has a right, by contract or otherwise, to control its votes, unless that right cannot be exercised now because it depends on an individual's death, bankruptcy or permanent disability (section 128(4); CRA Memorandum 14-7). A shareholder agreement, option or voting trust can break the test even when the holding company owns every share.

Each company must also pass one property or supply test. "All or substantially all" generally means 90% or more (CRA Memorandum 14-5).

Shares, partnership interests and loans are financial instruments, so the property test ignores them (CRA Memorandum 14-5). A holding company whose only property is shares of the operating company is tested on its supplies instead.

Which charges does the election cover, and which does it leave out?

The election covers taxable supplies between the two companies, except a sale of real property and any supply the recipient does not acquire for use exclusively in its commercial activities (section 156(2.1)). Rent for commercial space is a taxable supply (CRA).

The exclusive-commercial-use condition is tested supply by supply. A supply that is left out is taxed as if no election existed (CRA Memorandum 14-5).

What if the operating company does exempt work, such as a clinic, dental practice or home rentals?

An operating company whose income is mostly exempt generally cannot use the election, and the fee carries GST/HST that the operating company may not be able to recover. Most health and dental services performed for medical reasons, long-term residential rent and most financial services are exempt (CRA).

• Exempt only. A company that makes only exempt supplies generally cannot register (CRA). It is then not a registrant, so it cannot be a qualifying member.
• Mixed sales. A registrant with taxable and exempt sales must first pass the property or supply test above, which generally needs 90% or more of its supplies to be taxable, or of its property to be for commercial use. Even then, the election covers only a fee it uses exclusively in commercial activities (substantially all, generally 90% or more, of its intended use). Below that, the fee is left out and carries GST/HST.
• The holding company is tested too. A holding company with mostly exempt income, such as interest on loans or rent from homes, may fail the same test.
• Credits shrink. The operating company's credit on the fee follows its commercial use of the expense. The split is in GST/HST for medical and health clinics.
• The holding company still charges. If it is required to register, it adds the tax to the fee. A fee above the small-supplier limit makes that likely on its own.

For the categories, see exempt, zero-rated and out-of-scope supplies.

How do we make the election on Form RC4616, and by when?

File Form RC4616, signed for both companies, on or before the earlier of the two companies' GST/HST return due dates for the reporting period that includes the effective day (section 156(4); CRA form page).

1. Test both companies on the day the election is to start: ownership, registration, and the property or supply test.
2. Choose the effective day. From that day the supplier adds no GST/HST and the recipient claims no credit on these supplies. The CRA expects the stated day to match what the companies actually did (CRA Memorandum 14-5).
3. Complete Form RC4616. Part A names each company, its business number, whether it is a qualifying member, and the reporting period that includes the effective day. Part B states the election and effective day. In Part D, the first listed company certifies that it may file for all and will tell the others if the filing fails.
4. File before the deadline by sending the form to your tax centre, as the form directs (RC4616).
5. Keep the form and records showing both companies acted as if the election applied.

A monthly or quarterly return is due 1 month after its period ends, and an annual return 3 months after year-end for most businesses. The form must be received by the CRA by the earliest of those dates among the companies. For example, if one company reports by calendar quarter and the other by calendar year, an election effective January 1 is due April 30. A reporting period that is not a calendar quarter can make the date earlier, so use each company's actual return due date for the period containing the effective day (CRA Memorandum 14-5; RC4616).

A late form is generally not accepted. The Minister may allow a later filing day (section 156(4)), and the CRA does so only in exceptional circumstances. Its published conditions include a paper request to the first company's tax services office, an explanation of the delay, both companies meeting the tests on the effective day, no tax charged and no credit or rebate claimed on those supplies, all returns filed and tax paid, no open objection or appeal on the period, an effective day outside any period closed to reassessment, and no negligence. Accepting a late form does not confirm the election is valid (CRA Memorandum 14-5).

If a late form is not accepted, the fees or rent in the gap are taxable in the usual way. The holding company owes the tax even if it charged none, and the operating company can claim credits only within its commercial use and with the required invoice details.

What happens when the election ends, and who is liable if tax goes unpaid?

The election ends on the earlier of the day either company stops being a specified member of the group and the day both companies revoke it (section 156(3)). Taxable supplies between them are then taxed again.

• A company stops qualifying when, for example, ownership falls below the closely related test, it stops being a registrant, it becomes a party to a section 150(1) election, or it no longer passes the property or supply test (the operating company adds exempt work, say). Retest each year and after any change in ownership or business.
• Both companies may revoke on Part C of Form RC4616, with an effective day, under the same filing deadline as an election.

While the election applies, the two companies are jointly and severally liable for net tax that goes unaccounted for or unpaid if it is attributable to a supply between them. The liability also reaches supplies after the election ended if the companies keep acting as if it applied, and a purported election that was never valid (section 156(5)). If an audit finds the conditions were not met, the election has no effect and the CRA may assess unpaid GST/HST, interest and penalties (CRA Memorandum 14-5). The directors of a company that does not remit net tax can also be liable with it for the amount, interest and penalties, unless they used reasonable care to prevent the failure. The CRA cannot assess a director more than two years after the person last ceased to be a director (section 323).

What do the invoices and books look like with and without the election?

With the election, the holding company's invoice shows the fee or rent and no GST/HST. Without it, the invoice adds the tax, and the operating company claims it back to the extent it uses the service in commercial activities.

For what an invoice must show for a credit, see GST/HST receipt details for input tax credits. For the entries, see recording GST/HST in your books.

Example

These examples are illustrative. Figures are in Canadian dollars, and both companies are in Ontario where the HST rate is 13 percent.

Both companies registered, holding company owns all shares

A holding company owns all shares of an operating company that sells taxable services. Both are registrants. The holding company bills C$60,000 a year in management fees. With the election in effect, the invoice shows C$60,000 and no HST. Without it, the invoice shows C$60,000 plus C$7,800 of HST (C$67,800). The operating company pays C$67,800 and claims the C$7,800 as an input tax credit on its return.

The operating company makes only exempt sales

Assume an operating company earns only exempt health services, such as dental care for medical reasons. It generally cannot register and is not a qualifying member, so the same C$60,000 fee cannot be covered by the election. Assume the holding company is unregistered, has no other taxable sales or taxable associates, and bills C$5,000 on the first of each month from January 1. Its totals are C$15,000 after March, C$30,000 after June and C$45,000 after September. It stays a small supplier through October 31 and must charge HST from its November 1 fee. The November and December fees carry C$1,300 of HST, and a full year of fees carries C$7,800. The operating company cannot claim it, so that is a real cost.

A small fee, a large associate

• Year 1. A holding company owns the operating company's shares and bills no one. It makes no taxable supply and has no GST/HST number. The operating company makes C$500,000 of taxable sales.
• Year 2. The holding company starts billing C$12,000 a year. That is under C$30,000, but the operating company, still an associate, had C$500,000 of taxable sales in the four quarters before, so the holding company is not a small supplier. Its registration takes effect no later than its first taxable invoice, and it must apply within 29 days. It charges C$1,560 of HST (13 percent of C$12,000), unless both companies are registrants, qualify and make a valid election.

Different for you?

• Invoices went out, with or without tax, before anyone checked registration or the election, or the CRA has asked about the fees: the share register, registrations, returns and credit claims need review before choosing between charging, electing and correcting. Get corporate tax help. See also registered but did not charge GST/HST and correcting a filed GST/HST return.
• You want to know if the fee is reasonable, deductible, or could be treated as a dividend: see management fees between a holdco and opco.
• You are deciding whether to set up a holding company: see holding and investment corporations.
• You are unsure whether either company must register: see do you need to register for GST/HST.
• The charge is rent on a building, you personally own the building (an individual cannot make this election), or the building is being sold between the companies: see GST/HST on commercial property.
• The operating company has exempt or zero-rated sales: see exempt, zero-rated and out-of-scope supplies and GST/HST for medical and health clinics.
• The holding company only holds rental property: see books for a rental holding corporation.
• Either company is registered for QST, or sells in British Columbia, Saskatchewan or Manitoba: this election covers GST/HST only. The other taxes and the rate by province are in charging GST/HST, PST and QST by province.
• The companies are owned directly by the same individual, ownership is near the closely related line, or the operating company has mixed sales: the election may not fit. A corporate tax review of the structure comes before any filing. Get corporate tax help.