April 25th 2023
Management agreements between two public service body can sometimes be troublesome. Consultaxe explains the pitfalls to avoid.
Pitfalls to Avoid in Management Agreements between Public Service Bodies
If you are the manager of a public service body (non-profit organization, hospital, school service center, CEGEP, university, or municipality), you have probably already been involved in negotiating agreements between your organization and other partners. Generally speaking, the application of GST and QST in a public service body (hereinafter “PSB”) context is fraught with pitfalls due to the complexity of the provisions of the Excise Tax Act (hereinafter “ETA”) and the Act Respecting the Québec Sales Tax (hereinafter “QTA”) applicable to PSBs. Therefore, it is very important that managers be aware of the key risk factors when negotiating agreements between PSBs, particularly with respect to management agreements.
For example, it is very common for a municipality, a CEGEP, or a university (hereinafter, collectively, the “Client”) to enter into a management agreement with a non-profit organization (hereinafter an “NPO”) or a charitable organization (hereinafter a “CO”) for the latter to manage, maintain, and operate a building or equipment belonging to the Client.
Under this type of agreement, the NPO or CO could, for instance:
- act as a service provider;
- act as an agent/manager or a collecting agent and, as such, collect revenue for and on behalf of the Client;
- act as an agent/manager or a collecting agent, and remit GST and QST collected on behalf of the Client;
- act as an agent/manager for the Client for the purchase of certain goods or services.
Depending on the type of agreement, the NPO or CO may also be required to maintain an accounting of revenues and expenses for activities for which they are managers, agents, or collecting agents.
In this context, there are important elements to consider when determining the application of GST and QST to a management agreement:
- What is the GST/QST status of the Client, NPO or CO?
The first step is to determine the type of organization of the Client. Although the Client may be, for example, a university, a CEGEP, or a school service center, it may be designated as a CO. In this case, the organization would be considered a “public institution” for the purposes of the ETA and QTA.
This status as a public institution has important repercussions when it comes to determining the application of the GST and QST. For example, the supply of certain services made by a CEGEP that is a “public institution” will be tax exempt, whereas the same supply will be taxable when made by a CEGEP that is not a “public institution”.
Alternatively, where an NPO that is party to a management agreement with a municipality is a para-municipal organization, supplies between the municipality and the NPO may be exempt simply by virtue of that status.
- What is the legal relationship between the parties in the management agreement?
Determining the legal relationship between the parties in a management agreement is essential, as the application for GST and QST purposes may differ significantly depending on their legal relationship. For example, in a principal-agent relationship, the income received by the NPO or CO on behalf of the Client belongs to the Client. Therefore, the application of GST and QST will be based on the GST/QST status of the Client and not the status of the CO or NPO.
Thus, for example, if the Client is a “public institution” and, because of its status, the supply or service provided by the Client is exempt, the NPO performing the actual work must not collect the GST and QST on the consideration received, because it is performing the work as an agent of the Client, even though the work or supply would be taxable if the supply had formally been made by the NPO.
Furthermore, when an expense is made by the NPO or the CO as an agent of the Client, the recipient of the supplies is the Client; as a result, the GST and QST on the acquired supply are paid by the Client. Therefore, it is the Client and not the NPO or CO that is eligible for an ITC, ITR or rebate on non-creditable GST and QST.
Qualifying the legal relationship between the parties is crucial to establish how to apply the GST and QST, both in terms of collection and in terms of claiming ITCs, ITRs, and/or refunds. The accounting treatment should also reflect the legal relationship in order to support that relationship and the appropriate application of GST and QST.
- What is the nature of the supply?
Once the legal relationship between the parties is established, we identify the supply or supplies made between the parties and qualify them.
At this stage, there are several elements that must be taken into consideration. For instance, is it a supply of real property, tangible personal property, intangible personal property, or a service? Furthermore, when a supply is comprised of several distinct elements, we must determine whether it is considered a single supply or multiple supplies.
For example, sometimes the agreements between the parties include clauses that are similar to what is generally found in a management agreement and other clauses that are more common in an agreement relating to a real estate supply (lease).
Sometimes, agreements use terms such as “management services”, “manager”, or “agent”, whereas the intent and actions of the parties, upon verification of the facts, are not consistent with what is written in the agreement. Likewise, we have previously studied management agreements that included provisions for a supply of real property, but which do not have the characteristics usually found in a lease, for example, quiet use and enjoyment of the property, payment of the rent, and so on. Therefore, the tax authorities considered that it was rather a supply of a right to operate a business or a concession.
Defining the nature of the supply is essential, as it will determine its status and, sometimes, the timing of the collection of GST and QST.
- What is the status of the supply for GST and QST purposes?
Once all of the above steps have been completed, we determine the taxable or exempt status of the supplies, as well as how both parties can proceed in claiming ITCs, ITRs, and rebates for non-creditable taxes, if any.
In summary, in management agreements ― as in other types of agreements― the type of organization, both for the Client and the NPO or CO, as well as the nature of the supplies made between the parties, will have an impact on the status of the supply, the allowable ITCs and ITRs, as well as the percentage of allowable rebate.
If there is one thing to remember, it is that you must consider the risk factors associated with GST and QST when negotiating management agreements. This will avoid unpleasant surprises!
The information presented in this article is intended to provide information to Consultaxe clients and others whom the topic interests. The information presented herein is general. Before making a decision, readers should consult a professional advisor.
