Transfer of Assets Between Related Corporations and Partnership Rules

As announced in its 2004 Budget, Ontario proposes to modernize the retail sales tax rules relating to exempt transfer of assets between related corporations. In addition, proposals are pending that would regulate the rules for the transfer of assets between partnerships and their principals, including making those rules consistent with the rules for related corporations. The proposals are in response to a commitment to improve the fairness of the tax system, ensure all taxpayers pay their fair share of taxes and provide fair and consistent treatment of taxpayers.

A draft regulation proposing amendments to the related party asset transfer provisions, contained in Regulation 1013, is posted on the Ministry of Finance's website for industry review and comment. The release of the draft regulation builds upon the Government's commitment to consult with taxpayers on fairer and more effective tax policy.

The effective date proposed for the amendments is July 20, 2004, the release date of the draft regulation. Comments on the proposed amendments are requested to be received by September 3, 2004. It is expected that the amending regulation would be finalized by the Fall 2004. Until the amending regulation is in force, the current RST regulatory provisions remain applicable. Taxpayers should continue to keep records of related party asset transactions to respond to any future audits or to support any possible future RST refund.

The following is a description of the current tax treatment and proposed regulatory changes.

Transfer of Assets Between Related Corporations

The review of the related party asset transfer provisions has led to proposals that modernize the provisions to reflect current corporate restructuring and other related measures.

Beneficial Ownership

Current Treatment:

Regulation 1013 sets out that "wholly-owns" for corporations means the beneficial ownership, whether direct or through one other wholly-owned corporation, of not less than 95 per cent of the total issued and outstanding share capital of the corporation by a person and or by a person and one or more persons of the same family.

Proposed Treatment:

The regulation proposes to expand "wholly-owns" to include direct and indirect beneficial ownership of shares representing at least 95% of the stated capital of all classes and series of shares of the corporation. The expansion to indirect beneficial ownership allows the exemption to be used within the corporate group, providing the 95% beneficial ownership is met.

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Exempt Transfers between Related Corporations

Current Treatment:

The existing exemption for asset transfers between related corporations applies to tangible personal property (TPP) if tax imposed under the Act has been paid.

No tax is payable on a transfer of TPP from:

  • a person to a corporation wholly-owned by that person
  • a corporation to a person, who wholly-owns the corporation
  • a corporation to another corporation where both are wholly-owned by the same person

The related party exemption can only be used once with respect to a particular asset.

Proposed Treatment:

Amendments are proposed to introduce specific rules for the exemption:

  1. Assets to be transferred tax exempt would be considered as "eligible property" or property on which tax has been paid under the Act.
  2. No tax is payable on any transfer of eligible property.
    • a person to a corporation wholly-owned by that person
    • a corporation to a person, who wholly-owns the corporation
    • a corporation to another corporation where both are wholly-owned by the same person.
  3. The wholly-owned relationship between the related corporations must continue for a period of at least 180 days following the date of the transfer of the asset.

The addition of the concept of "eligible property" sets the parameters for assets which may be transferred between related parties on a tax-exempt basis. Tax will not be considered to have been paid if an exemption was claimed under the Act when the property was acquired or if the property was acquired for the purpose of resale. The concept ensures RST is paid once by the corporate group.

However, if a purchasing corporation is entitled to an exemption under the Act, that exemption may still be used. For example: Corporation A, a manufacturer, purchases manufacturing equipment and claims an exemption from RST. Corporation A transfers the equipment to Corporation B, a related corporation, but since A did not pay tax on the equipment, B must now pay the tax (albeit on the fair market value at the time of the transfer). However, if B is also a manufacturer, and the equipment is to be used as manufacturing equipment, B may claim an exemption from RST on the transfer.

The proposed rules also remove the one-time limitation for using the related party tax exemption. The rules introduce a requirement for the parties to remain related for 180 days to ensure that the asset transfer was between bona fide related parties.

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Examples of Exempt Transactions between Wholly-Owned Corporations

Example 1: In Figure 1, A, B and C are related corporations as B and C are wholly-owned by A. Eligible property (ie. where tax has been paid once on the asset by either A, B or C) may be transferred between A, B and C without the payment of tax.

Diagram depicting one-level corporate structure within which property can be transferred without the payment of retail sales tax.

Figure 1

Example 2: In addition to the tax exempt transfers outlined in Example 1, eligible property could be transferred between A, B, C and D based on the corporate relationship.

Diagram depicting corporate structure, including another wholly-owned corporation, within which property can be transferred without the payment of retail sales tax.

Figure 2

Example 3: Figure 3 expands the tax exempt transfers outlined in Example 2. Corporations A, B and C or B, D and E may transfer eligible property without attracting tax (same as Example 1). Eligible property may also be transferred among A, B, C, D, E, F and H without attracting tax because of the unbroken chain of at least 95% beneficial ownership between each of the corporations (same as Example 2). Also, because of the chain of 95% beneficial ownership, G can transfer eligible property to each of these corporations without attracting tax .

However, as with Example 2, the transfers could only be exempt if they were a result of transfers between wholly-owned corporations. With the indirect nature of some of the transfers, evidence to document the beneficial ownership must be available.

Diagram depicting multi-level corporate structure, including other wholly-owned corporations, within which property can be transferred without the payment of retail sales tax.

Figure 3

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Transfer of Assets Between Unrelated Corporations

Unrelated corporations are those corporations that are not wholly-owned by another corporation or an individual. The review of the provisions relating to asset transfers between these corporations included ensuring that tax was pro-rated in a manner consistent with the pro-rating of tax on the transfer of assets between partners and partnerships.

Current Treatment:

Where a person purchases TPP from a corporation the purchaser does not wholly-own, tax is payable on the portion of the actual value of the TPP that reflects the proportion of the share capital not owned by the purchaser.

Tax is not pro-rated in any other situations.

Proposed Treatment:

Based on administrative policy, tax has been pro-rated on the transfer of assets between partners and partnerships. Similar treatment is being proposed for unrelated corporations (ie. not wholly-owned by an individual or corporation).

The rules propose that no tax would be payable on the portion of the value of the eligible property transferred that relates to the proportion of the share capital owned on the transfer between:

  • unrelated corporations and the transferor owns shares directly or indirectly of the purchaser before the sale.
  • unrelated corporations and the purchaser owns shares directly or indirectly of the transferor before the sale.
  • eligible shareholder to a corporation, or vice verse, and the eligible shareholder owns shares directly or indirectly of the corporation. (Eligible shareholder refers to an individual or partnership that directly or indirectly owns shares of the corporation, but does not wholly own the corporation.)

The shares used to calculate the proportion must continue to be held for 180 days after the transfer.

Example of Transfer between Unrelated Corporations

In Figure 4, A wishes to transfer a tax paid asset to G. To do this, A would transfer the asset to D, without the payment of tax due to A's indirect beneficial ownership of D. D's 30% interest would be transferred to G. Since D only owns 30% of G, G would be required to pay tax on 70% of the fair value of the asset being transferred.

Diagram depicting corporate structure where wholly-owned corporation relationships do not exist, resulting in the partial payment of retail sales tax.

Figure 4

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Additional Amendments

Current Treatment:

Under the current rules, if a person receives shares as consideration for the full value of the TPP sold, and retains the shares for a period of not less than 6 months, the transfer is exempt.

If the value of the TPP is greater than the value of the shares transferred, tax is owing on the difference.

Proposed Treatment:

To be consistent with the proposed changes to permit the pro-rating of tax on assets transferred between unrelated corporations, an amendment to the rule regarding shares received as consideration is also proposed. If a person receives shares as consideration for eligible property and retains the shares for a period of not less than 180 days, the shares will be taken into account in determining the portion of the value on which no tax would be payable.

To accommodate other proposed changes, if shares are transferred to a family member or corporation upon wind-up, dissolution or amalgamation, provided a 180 day relationship is maintained or the shares are held by the receiving corporation for 180 days (discussed further), the 180-day holding period requirement would be deemed to be met. In addition, a 180-day holding period requirement would be deemed to be met in cases where a corporation is amalgamated, wound-up or dissolved.

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Partnerships

Finally, the administrative policy relating to the transfer of assets between partners and partnerships was reviewed to ensure that the rules for these transfers were similar to the existing and proposed rules for asset transfers between related parties.

Current Treatment:

The current treatment of partnerships under the Act is set out in RST Guide #210 - Partnerships. In summary, the following rules currently apply to partnerships:

No tax is payable on the following transfers of TPP:

  • Transfer of TPP from the partnership to a partner, providing the partner had contributed the TPP to the partnership and had originally paid the tax.
  • Contribution of TPP on the formation of a new partnership providing each partner paid the applicable RST when the TPP was purchased.

Tax payable is pro-rated on the following transfer of TPP:

  • TPP transferred into a partnership by a partner, on the basis of the percentage interest of the partnership held by the partner.

Tax is payable on the following transfers of TPP:

  • Transfer of TPP purchased tax exempt by a partnership, to a partner.
  • Transfer of TPP from a partnership to a partner, where the TPP was contributed to the partnership by other partners.
  • Transfer of TPP from a partnership to a partner, where TPP was contributed to the partnership by the same partner, but tax had not been paid by the partner.

Administrative policy for partnerships also permits the transfer of assets into a partnership without the payment of tax, in exchange for an interest in the partnership as well as the assumption of liabilities.

Proposed Treatment:

The proposed regulation includes rules previously set out in the RST Guide #210 - Partnerships, but also proposes new rules to bring partnership asset transfer rules in line with those for related party transfers.

Similar to the proposed rules for related party asset transfers, partnership assets transferred for which no tax is payable or pro-rated, must be eligible property, or property on which RST has previously been paid.

No tax is payable on the portion of the value of eligible property transferred:

  1. into a partnership that relates to the percentage share of the income or loss of the partnership that the person will receive after the transfer.
  2. from a partnership to a partner that relates to the percentage share of the income or loss of the partnership that the partner holds, providing the property had not been transferred into the partnership by another partner.

If the transfer of eligible property is a result of one of the following, no tax is payable on the transfer:

  1. from a person to a partnership, on the creation of the partnership, providing the value of consideration paid for the property does not exceed the value of the partnership interest received by the person
  2. from a partnership to a partner if that partner had originally transferred the property to the partnership on its creation.

The proposed rules limit the value of the property that may be transferred without the payment of tax to the value of the partnership interest that is received in exchange.

No tax is payable in respect of the transfer of an interest in a partnership from a partner to another person.

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Feedback

Written submissions providing comments on the draft regulations should be submitted by September 3, 2004. Submissions should be addressed to:

Ms Brenda Kershaw
Corporate and Commodity Taxation Branch
Ministry of Finance
Frost Building North
2nd Floor, 95 Grosvenor Street
Queens Park
Toronto, Ontario
M7A 1Z1

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