TELEPHONE 954-8585
FACSIMILE 990-1233
11725-1(sn)
Dear Mr. XXXXX
Further to your letter of July 12, 1994 which requests our comments on the relationship existing XXXXX we have now had an opportunity to review the background material provided and our comments are summarized as follows. Please excuse the delay in our response.
Background
1. It has been proposed that an adjustment of XXXXX of GST be assessed to XXXXX for the period from January 1, 1991 to October 31, 1993. The proposed assessment relates to GST payable on office operating expenses initially paid by XXXXX but reimbursed by XXXXX[.]
2. XXXXX is a registrant for purposes of GST. XXXXX has been filing input tax credit claims to recover the GST paid on office operating expenses. XXXXX has not been charging GST on the reimbursement of those expenses by XXXXX are not GST registrants.
3. XXXXX are each a 25% shareholder of XXXXX[.]
4. XXXXX was incorporated in 1988 with the stated purpose of "acting as agent for its principals XXXXX in respect to (the expenditures which are the subject of a proposed GST assessment). XXXXX was created to allow the principals to consolidate the earning of certain commission income and to jointly share expenses of conducting their separate insurance businesses."
5. Written correspondence received from XXXXX on April 6, 1994 and June 29, 1994 presents arguments and evidence to support the claims made by XXXXX is acting as their agent in incurring the expenditures under assessment.
Discussion
Any discussion of a relationship which is represented to be one of agency and the application of GST to such a relationship will involve a two-step decision process. It must first be determined if one person is the agent of another ("the principal"). If a person is an agent of a principal, it must then be determined if that person is in fact acting as agent (particularly in respect of specific expenses incurred). In this regard, it is possible for a person to be an agent but not to undertake certain actions in his role as agent. Stated otherwise, a person can act as an agent in some activities, but not in respect of other activities.
As is discussed in GST Policy Statement 182 - "Determining the meaning of "Agent" and "Agency"["], a person will be considered and treated for GST purposes as an agent based on fact and the principles of law. Further, it is not possible to provide a ruling on the existence of agency between two particular persons. The Department will provide a ruling or interpretation on the application of the GST legislation after accepting or rejecting the existence of agency. The Essential Qualities of Agency and the Indicators of Agency, as developed and discussed in Policy Statement 182, are factors which the Department will apply in accepting or rejecting the existence of agency. These factors have been used to evaluate the evidence provided by XXXXX to support the claim of agency existing between XXXXX[.] The evaluation is attached as Appendix A.
XXXXX have a stated position that an agency relationship exists between them such that XXXXX acts as the agent of XXXXX with respect to the payment of certain general office expenses. The Department will accept the assertion of an agency relationship between the parties as a result of the analysis attached as Appendix A. It remains now to determine whether XXXXX is acting as the agent of XXXXX with respect to the payment of the general office expenses. To the extent that XXXXX is incurring and paying expenses with respect to its own operations, XXXXX is acting on its own behalf and not as agent for any third party principal. For XXXXX to be acting as agent in the payment of certain office expenses, the expenses must be those person for whom XXXXX acting as agent. In this particular case, the expenses must be those of XXXXX[.] Although it should not be viewed as definitive evidence to the contrary, if XXXXX was acting as agent in paying the office expenses of its principals, XXXXX should not be filing input tax credit claims with respect to such expenses since XXXXX would not be the recipient of those expenses.
We would be pleased to provided any assistance you might require to arrive at such a determination. Should you require any further assistance in this matter, contact one of the members of the Application Team in the Tax Provisions Unit. They are: Ken Mathews (613) 952-9585, Suzanne Leclaire (613) 954-7931, and Sara Nixon (613) 954-4397.
Yours truly,
H.L. Jones
Director
General Applications Division
GST Rulings & Interpretations
642(REG)
Mitch Bloom (signoff)
c.c.: Application Team
Appendix A
Essential Qualities of Agency
Consent of both the Principal and the Agent
Has the other party agreed to having the person act as his agent?
Has the person agreed to act as the agent of the other party?
Is there a written agreement evidencing this arrangement?
Is there a verbal agreement evidencing this arrangement?
Do the actions of the person and the other party evidence this arrangement?
There is no formal written agreement evidencing an agency relationship between XXXXX[.] There is no first-hand evidence of a verbal agency agreement. XXXXX in its capacity as representative of XXXXX has made the written statement that XXXXX was acting as agent for its principals XXXXX and that "The relationship is self-evident from the course of conduct of the parties." The accountant responsible for the preparation of the annual financial statements of XXXXX since its inception has also submitted a written statement that "the use of the company was designed for you XXXXX to provide a central point for the payment of the business overhead expenses for the four company partners ... and that the company operated as a distribution agent for the four members and this cost sharing arrangement was and is still in effect." Therefore, regardless of the lack of both written and verbal agreements, it is the stated position of all parties involved that an agency relationship does exist.
As to whether the four shareholders has agreed to having XXXXX act as their agent and whether XXXXX has agreed to act as the agent of the four shareholders and whether the actions of XXXXX and the four shareholders evidence agency, when these particular qualities are used to evaluate the relationship existing between XXXXX the discussion must be viewed as academic due the stated assertion of the parties that agency exists and to the specific ownership and management relationship which exists between XXXXX and its four shareholders. XXXXX is equally owned by the four persons which XXXXX purporting to act as agent for. Although there appears to be an intent that XXXXX will eventually carry on a business in its own right, on review of the financial statements provided, the sole activity of XXXXX for the period of the proposed assessment, is paying the expenses of the operations of the businesses of the four shareholders. If XXXXX [d]id not exist to pay those expenses, the four shareholders would each have no option but to make arrangements to pay those expenses directly.
The financial statements for the 1991 and 1992 October 31 year-ends have been provided. To that date XXXXX has earned minimal revenue of its own, none of which appears to be associated with the payment of expenses on behalf of shareholders. The accountant who has prepared the financial statements has stated that "The company has never received fees from the members but only received an amount which represented a recovery of expenses to be paid out by this one distribution centre.". Any funding required in excess of the recovery of expenses paid, has been provided by shareholder loans.
Hand-written minutes of a meeting of September 9, 1988 have been submitted for review and in defence of the existence of an agency relationship. These minutes are silent as to any direct discussion of an agency relationship, however, the actions to be taken by the four shareholders would imply agency. The minutes provide a degree of evidence that the four shareholders made all of the decisions of XXXXX as far as purchasing capital assets and entering into a lease. There is also evidence that shareholders made direct payments to suppliers in order to purchase assets for XXXXX.
Given these circumstances, it would appear that XXXXX is, but for its separate incorporation, nothing more than an extension of its four shareholders and that the relationship existing between them could be nothing else but agency even though it is not formally evidenced. This is not to say that a corporation is always the agent of its shareholders. It is a basic principal of corporate law that corporations exist separately and apart from their shareholders and that in acting, the corporation cannot automatically be said to be acting "on behalf of" its shareholders. However, it is reasonable to distinguish the relationship existing between a publicly traded company and any particular shareholder from the relationship existing between an incorporated small business and its shareholders which are usually also the directors of the company. In instances where shareholders and directors are the same persons, the existence of an implicit agency relationship should be anticipated even though there may be no formal evidence. Indeed, it is unlikely that formal evidence will exist in such circumstances because the shareholders view the corporation as an extension of themselves but for the protection it affords them with respect to personal liability. There is no question that XXXXX is a separate person from its four shareholders and that it is capable of acting in its own right. If it acts in a manner which creates a legal liability, the corporation and not the shareholders, will be liable. However, this does not preclude the corporation from legally being able to act as agent of its shareholders, if such action is desired by all parties.
Authority of the Agent to Affect the Principal's Legal Position
Has the other party given the person the "power" to affect the other party's legal position?
Can the person bind the other party in a contractual agreement with a third party?
Can the person pay an amount that was the legal liability of the other party?
Does the person conduct itself in such a manner that the other person's legal position is affected?
The principles of law indicate that in a true agency relationship it should be evident that a person acting in the capacity of agent is empowered by the principal to act or enter into contracts on behalf of that principal. It must be understood that the ability to bind is not synonymous with the authority to contract. It is not enough for a person to able to bind another, that is to affect the other person's legal position, for agency to exist. The agent must be able to bind the principal through contracting. The most common example of an agent binding the principal is where the agent is authorized to enter into contracts with third parties on behalf of the principal. XXXXX has entered into a lease with XXXXX for office space and with XXXXX for a telephone system. In both instances, XXXXX has contracted in its own name although all of the leases have been guaranteed by one or more of the four shareholders.
As previously discussed, there is no question that legally, XXXXX is a separate person from its shareholders and that in theory, there should be no question that it should be able to contract on its own behalf or for that matter, anyone else's. It is therefore not significant in and of itself that XXXXX is able to contract. The question is whether the real property lease and telephone lease were entered into on behalf of the principals. Since each of the four shareholders required both office space and a telephone system to run their separate insurance businesses and it is the office space leased by XXXXX and the telephone system leased by XXXXX which are the facilities being used by all of the shareholders, it is reasonable to conclude that XXXXX must have entered into the leases on behalf of the shareholders since XXXXX had no other reason to enter into the leases.
The cogent point to be noted with respect to XXXXX ability to contract is its apparent inability to do so without the guarantees of one or more of the shareholders. This supports the view that XXXXX is merely an extension of the four shareholders and that without their guarantees to support any contract entered into the XXXXX there was effectively no substance behind XXXXX signature on the contract. For all intents and purposes, the signature of XXXXX is the signature of the shareholders.
The Principal's Control of the Agent's Actions
Does the other party have the power to control the actions of the person?
Does the other party retain the right to approve certain expenditures?
Does the other party require periodic reports?
With respect to the ability of the four shareholders to control the actions of XXXXX as the previous discussion has highlighted, XXXXX appears to be incapable of acting on its own. Although it should in theory, be able to contract, practically it cannot do so without the guarantees of the shareholders. XXXXX has indicated that it was the shareholders who negotiated the actual terms of all of the leases although the leases were entered into by XXXXX[.] The management of XXXXX is the four shareholders on whose behalf it operates. It must therefore be concluded that the four shareholders have complete control over the action of XXXXX and retain the right to approve all expenditures.
Indicators of Agency Relationship
The financial statements for the year-ends October 31, 1991 and October 31, 1992 have been provided for our review. The proposed assessment includes the 1993 fiscal year as well. We have no documentation for the last year and are therefore not in a position to comment on the activities of XXXXX for the third year under review. The following comments are applicable only to the 1991 and 1992 fiscal years. It is possible that the activities of XXXXX could have changed significantly in the third year such that some of our comments would not be applicable to that period.
Remuneration
Is the person paid a set fee for services rendered rather than earning revenue by making a profit?
Is the person remunerated for services rendered, i.e., an hourly wage, a percentage of the supply bought or sold?
Is the person being reimbursed for expenses incurred on his behalf?
Remuneration of an agent is generally on the basis of a set fee for the activities undertaken to be completed by the agent. It appears that the only fee revenue earned by XXXXX in 1991 and 1992 is the recovery of the operating costs it incurs on behalf of the four shareholders and that XXXXX does not add a profit element when it bills to recover the operating expenses of the four shareholders. The accountant for XXXXX have both stated tha[t] XXXXX is not paid a commission for its services as agent. This should be independently verified by a review of the documentation which supports the revenue being disclosed on the financial statements. The lack of a fee being charged by XXXXX does not confirm or disprove the existence of an agency relationship. It does lend a degree of credibility to the argument that XXXXX is merely a separate corporate extension of the businesses of the four shareholders and that therefore it is not possible for XXXXX to be anything but an agent. However, the sources of all revenue recorded by XXXXX should be clearly ascertained. If XXXXX is earning its own revenue from its own business activities with persons other than the four shareholders (e.g. income tax return preparation service) or if XXXXX is found to be purchasing and reselling at a mark-up, to the four shareholders, these activities are not done by XXXXX in its role of agent. If such revenue sources exist, it must be assumed that expenses will be incurred to earn such revenues and that those expenses are also not incurred as agent of any third party. They would be the expenses of XXXXX itself.
Ownership of Property
Do title and ownership pass directly to the other party rather than resting with the person?
Does the right to use the property or service rest with the other party rather than the person?
There is no direct evidence in the documentation provided for our review as to whether title and ownership of property pass directly to the four shareholders or whether such qualities rest with XXXXX[.] It is assumed that since XXXXX can contract, invoices and other similar billings are made out to XXXXX after purchase orders are issued under the direction of one or more of the four shareholders. Therefore it would appear that XXXXX is acquiring title and ownership.
There is also no evidence provided as to whether the right to use the property or service acquired by XXXXX or the four shareholders. It must be determined whether XXXXX has any business activities of its own. If it does not, it is reasonable to assume that XXXXX has no need of its own to acquire property or services. If however, XXXXX commenced to provide income tax preparation services or some other business of its own during the 1993 fiscal year, it must assumed tha[t] XXXXX would need to incur expenses of its own.
Liability for Payment
Does legal liability for payment rest with the other party rather than the person?
If XXXXX is the agent of the four shareholders, to the extent that XXXXX is acting as agent in paying the business expenses of the four shareholders, the liability for payment should rest with the four shareholders and not with XXXXX[.] The documentation provided for our review does not provide enough detail for any clear conclusion on this issue. Copies of the lease which is presumably for the office space and the lease for the telephone system have been submitted for our review. It does not appear that XXXXX has entered into these contracts as agent for the four shareholders. It appears that XXXXX has entered into the contracts in its own name, but one or more of the shareholders is providing a personal guarantee. This would mean that there is some degree of legal liability for payment resting with XXXXX[.] But it also adds to the argument that XXXXX does not really exist in its own right. Although technically, XXXXX should be able to contract on its own, any third party contracting with XXXXX essentially looks through XXXXX to the four shareholders, for payment. A review of the ongoing expenses being paid by XXXXX should be conducted to more clearly determine payment arrangements and where legal liability for payment would rest.
Accounting Practices
Does the person ignore that revenue(asset) or expense (liability) in its book of accounts?
Does the person ignore that revenue or expense for income tax purposes?
Does the person separate from its own monies any money received or paid out which is considered to be that of the other party?
For the period under review, the financial statements of XXXXX do not indicate that XXXXX has any activities of its own, although such activities, i.e. an income tax return preparation service, are contemplated. Therefore, it cannot be said that XXXXX has any of its own monies. All of its cash comes from either shareholder advances or reimbursements of expenses paid on behalf of the shareholders.
XXXXX treats the reimbursements received as fee revenue. This is perhaps an unusual description of what would normally be viewed from an accounting perspective, as expense recoveries. A more standard disclosure would be to net the expense with the amount of the recovery. However, if a netting process was used, there would effectively be no income statement for XXXXX since total recoveries equal total expenses. The accountant responsible for the preparation of XXXXX financial statements has acknowledged that his disclosure of the activities of XXXXX is perhaps not usual, but he has stated that the gross expense and recovery disclosure method was chosen deliberately to provide information to the four shareholders on the annual total of each office expense category. This seems to be a reasonable explanation to accept. Ultimately, it is the four shareholders who are each recognizing their proportionate share of office expenses for income tax purposes, when the reimbursements are paid to XXXXX[.]
Best Efforts
Does the person undertake to use his best efforts for the other party rather than assume liability to provide a specific supply?
The documentation provided does not provide us with information to determine this issue. Whether XXXXX is using its best efforts when incurring the business expenses of the four shareholders is something that must be determined through a review of a sample of expenses and a comparison to alternatives which might have been available. Did XXXXX get the best price and the best credit terms are factors to be considered. Whether XXXXX is in fact able to act independently from the shareholders is also a significant factor. If the best efforts of XXXXX are for all intents and purposes, the best efforts of the four shareholders, this indicator may not be particularly relevant.
Assumption of Risk
Does the person disavow any risk of loss from the transaction with the third party?
This particular indicator is probably only useful for reviewing major purchases being made by XXXXX[.] In such cases, XXXXX can be said to be generally not at risk in that one or more of the four shareholders is personally guaranteeing all significant purchases.
Alteration of Property Acquired
Does the person maintain the supply acquired in the same form as acquired?
Does the person maintain the supply acquired in the same quantity as acquired?
Does the person maintain the supply acquired in the same quality as acquired?
XXXXX does not alter any of the property or services it acquires.
Use of Property or Service by Agent
Is the supply neither consumed nor used by the person in providing the person's own supply?
XXXXX does not consume or use any of the property or services it acquires.
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