Tax Insights: GST/HST issues for limited partnerships investing in real estate

August 21, 2018

Issue 2018-30

In brief

In the 2018 federal budget, the Department of Finance confirmed its intention to proceed with legislative proposals that impact investment limited partnerships (ILPs). These proposals have the effect of deeming management or administrative services provided by the general partner (GP) of an ILP to be taxable services, such that the GP is required to collect GST/HST on the fair market value of the services.

This Tax Insights discusses when a limited partnership is considered to be an ILP, with a focus on limited partnerships that invest in real estate.

In detail

What is an ILP?

For a limited partnership to be considered an ILP, the following conditions must be met:

  • the primary purpose of the partnership must be to invest funds in property consisting primarily of financial instruments (e.g. shares, debt, partnership interests), and
  • either:

– the limited partnership is, or forms part of an arrangement or structure that is, represented or promoted as a hedge fund, investment limited partnership, mutual fund, private equity fund, venture capital fund or other similar collective investment vehicle, or

– the total value of all interests in the limited partnership held by listed financial institutions is 50% or more of the total value of all interests in the limited partnership

Will a limited partnership investing in real estate be an ILP?

While a limited partnership that directly owns real estate may not be considered an ILP because its primary purpose is to own real estate, a limited partnership that is a holding partnership with underlying partnerships, corporations or trusts that own underlying real estate may be an ILP if its primary purpose is to invest funds.

Canada Revenue Agency (CRA) GST/HST Notice No. 308 (July 2018) confirms that a limited partnership that acts as a collective investment vehicle to indirectly own real estate by acquiring interests in other partnerships may be an ILP. Specifically, the CRA provides the following examples of a limited partnership that would be considered an ILP:

  • Example 1: A limited partnership that uses all of the capital it has raised from issuing a prospectus to acquire interests in other limited partnerships that invest in commercial and residential real property.
  • Example 7: A limited partnership that is promoted as an ILP that invests in real estate projects, with all of its investments in real estate occurring indirectly through partnerships, trusts, etc.

When is a partnership’s primary purpose to invest in financial instruments?

For GST/HST purposes, a financial instrument includes, among others, a partnership interest, debt securities, equity securities and interests in a trust. While “investing funds in property” is not defined, it has generally been interpreted to include transactions such as the purchase of property for the income that it can generate or for potential profit on resale.

To determine a partnership’s “primary purpose,” consideration is given to the partnership’s intentions, its principal business and its principal activity, which, as discussed by the Tax Court of Canada in The College of Applied Arts and Technology Pension Plan (2003 TCC 618), depend on the importance of the activity to the achievement of the organization's goals or purposes.

A person’s (or partnership’s) intentions are generally determined based on their whole course of conduct based on an objective review of the conduct and the steps taken to carry out the intentions. In determining a partnership’s principal business, the CRA references the following factors in GST/HST Memorandum 17.6 (July 2014):

  • the relative profits realized by each segment of a person's business
  • the total number of supplies made and the total value of the revenue received from supplies made in each business activity
  • the relative value of the assets employed in each business activity
  • the commercial practices of the person, including the time, attention and efforts expended by the employees, managers, or corporate officers in each business activity
  • the terms of any partnership agreement if the person is a partnership

These factors should also be relevant in assessing a partnership’s primary purpose, such that a limited partnership that directly owns real estate should not have a primary purpose of investing in financial instruments (e.g. other partnerships) when:

  • the value of its directly owned real estate exceeds the value of the financial instruments that it owns, or
  • it directly owns real estate and most of its resources are devoted to directly acquiring or managing the real estate instead of managing its investments in financial instruments (e.g. other partnerships), which, given the minimal amount of resources required by a passive investor (i.e. a limited partner), is quite plausible even if the value of its investment in financial instruments exceeds the value of the directly owned real estate

When is a partnership represented as a collective investment vehicle or held 50% by listed financial institutions?

As noted, an ILP must also be represented or promoted as a type of collective investment vehicle or be held 50% by listed financial institutions.

There is some uncertainty as to when a limited partnership is considered to be represented or promoted as a particular class of collective investment vehicle. However, given that a separate rule captures partnerships with listed financial institutions as investors, merely having multiple limited partners does not, in and of itself, make a limited partnership an ILP. Rather, some form of offering memorandum or prospectus is generally needed to be issued to potential investors, which is consistent with the examples set out in CRA GST/HST Notice No. 308.

A “listed financial institution” is defined to include banks, securities dealers, insurers and investment plans. An “investment plan” includes investment corporations, mutual fund corporations and certain types of trusts, including those governed by a registered pension plan, an employee profit sharing plan, an employee benefit plan, a mutual fund trust or a unit trust and, effective January 1, 2019, an ILP.

As such, a limited partnership whose investors are primarily pension plans or other investment plans will generally be an ILP if its primary purpose is to invest in funds consisting mainly of financial instruments.

Is the GP providing management or administrative services to the ILP?

For GST/HST purposes, a “management or administrative service” is defined to expressly include an “asset management service.” An “asset management service” is defined to include functions such as managing the assets or liabilities of a person, providing research, analysis and advice in respect of assets, determining which assets to acquire or dispose of and acting to realize performance targets or other objectives in respect of the assets.

Based on a GP’s powers to manage the affairs of a limited partnership, the services that it provides will be considered to include management or administrative services and thus the GP of an ILP will be required to collect GST/HST on the fair market value of these services.

What is the fair market value of the GP’s services to an ILP?

Canadian courts have generally interpreted “fair market value” to mean the highest price an item might reasonably be expected to bring if sold in:

  • the normal method for the sale of the particular item in the ordinary course of business
  • a market that has not been exposed to any undue stress and is composed of willing buyers and sellers that deal at arm’s length and under no compulsion to buy or sell

The above interpretation is supported by CRA GST/HST Notice No. 308.

When an ILP is merely a passive investor in another limited partnership (i.e. the ILP is a limited partner), the services that the GP actually provides to the ILP should be fairly limited as the ILP’s activities are generally limited to dealing with its investors and receiving distributions from the underlying limited partnership. Therefore, the value of the GP’s services to the ILP should be minimal and the fact that the GP may receive an allocation of profit should not affect the value of the service it provides to the ILP.

In other words, it is the underlying limited partnership that owns the property that requires the vast majority of management and administrative services, and the GP of the ILP is not providing these services to the ILP.

How PwC can help

PwC can help to assess if a limited partnership is an ILP and if it is:

  • assist the GP in complying with its obligations to collect GST/HST
  • minimize the impact that the proposed legislation may have on the ILP by restructuring management agreements
  • quantify the services that are in fact being provided by the GP of the ILP

Contact us

Brent Murray

Partner, PwC Law LLP

Tel: +1 416 947 8960

Chris Potter

Partner Real Estate, Tax, PwC Canada

Tel: +1 416 869 2494

Susan Farina

Partner, PwC Canada

Tel: +1 905 326 5325

Wayne Mandel

Senior Manager, PwC Canada

Tel: + 1 905 738 2914

Follow PwC Canada