The situation regarding COVID-19 is changing rapidly. This post is current as of April 19, 2020.
The focus of this article is “qualifying revenue”. It is the amount of qualifying revenue that is used to determine whether an applicant meets the revenue reduction condition under the Canada Emergency Wage Subsidy (“CEWS”). This article highlights some aspects of the computation of qualifying revenue.
Meaning of "Qualifying Revenue"
According to the CEWS legislation, “qualifying revenue of an eligible entity” is the inflow of cash, receivables or other consideration arising in the course of the ordinary activities of the eligible entity in Canada generally from the sale of goods, the rendering of services and the use by others of resources of the eligible entity. It should be generally determined in accordance with its normal accounting practices. It does not include extraordinary items as well as benefits under the CEWS or the 10% temporary wage subsidy program. Special rules apply to registered charities and tax-exempt entities relating to the determination of qualifying revenue.
Qualifying revenue also excludes revenue from persons or partnerships not dealing at arm’s length with the eligible entity. This is consistent with the legislative intention to measure the revenue decline based on revenue from arm’s length sources. However, this could be problematic for a group of companies.
Special Rules for Groups
Some corporate structures have a dedicated service company that pays employees who provide services to other companies. Professional service firms might have a management company that hires employees who provide services to the affiliated partnership. Fortunately, the legislation contains special rules relating to the determination of qualifying revenue for a group of entities.
This first rule applies where consolidated financial statements are normally prepared for a group of eligible entities. Thus, the group is determined based on the consolidated financial statements. The entities included in those statements are part of the group.
Each member of the group may determine its revenue separately as long as every member determines it on the same basis. No election is required.
The second rule applies to an “affiliated group of eligible entities”. This is the phrase used in the CEWS legislation in respect of this second rule in paragraph 125.7(4)(b) of the Income Tax Act (Canada) (the “Act”).
The Act contains provisions for determining whether a person is “affiliated” with another in section 251.1 and a definition of an “affiliated group of persons” in subsection 251.1(3) of the Act. But this definition applies only to section 251.1. No amendment was made to extend its scope to the CEWS provisions. Consequently, it is uncertain whether the government intended to adopt the existing concept of an affiliated group or a different concept for purposes of the CEWS. In either case, it seems that further clarification or amendments are required.
In contrast to the first rule, this second rule requires a joint election. Each member of the group can use the revenue of the group determined on a consolidated basis if every member jointly elects to do so.
Reflecting on the first two rules, an affiliated group that normally prepares consolidated financial statements would have a couple of choices. Each member can jointly elect to use the revenue of the group determined on a consolidated basis. Alternatively, each member can determine its revenue separately.
I suppose, in theory, that some members could attempt to use separate revenues and others use the consolidated revenue. But in this case, neither option would be available for any member of the group.
The third rule applies to a joint venture, the participants of which own all of the interests of an eligible entity. It seems to contemplate a scenario where an eligible entity pays employees who provide services to the venture. In this type of scenario, the eligible entity may use the revenue of the venture instead of its own revenue. For this purpose, the revenue of the joint venture is determined as if it were an eligible entity.
Dedicated Service Company
The fourth rule applies where all or substantially all of an entity’s revenue comes from one or more persons or partnerships with which the entity does not deal at arm’s length. This seems to contemplate a dedicated service company that provides services to another non-arm’s length entity. For example, a law firm partnership structure might have a management company that pays employees who provides services to the partnership. If applicable, this rule would generally allow the entity to use the revenue of the partnership from arm’s-length customers or clients.
There is an anti-avoidance rule relating to qualifying revenues. Its application depends on two conditions:
- The first condition is met if the eligible entity, or a person or partnership not dealing at arm’s length with the eligible entity, enters into a transaction or participates in an event (or a series of transactions or events) or takes an action (or fails to take an action) that has the effect of reducing the qualifying revenues.
- The second condition is a purpose test. This condition is met if it is reasonable to conclude that one of the main purposes of the transaction, event or series of action is to cause an eligible entity to qualify for the subsidy.
If the anti-avoidance rule applies, the entity would not qualify for the subsidy. The legislation would deem the qualifying revenue for the current period to be equal to the qualifying revenue of the prior period benchmark. This would eliminate any decline in revenue.
In addition, the eligible entity would face a penalty. The penalty would be equal to 25% of the amount that would have been the entity’s subsidy calculated based on information provided in the entity’s application for the subsidy.
The anti-avoidance rule seems broad. Suppose that a company’s action or inaction causes invoices to be issued to a customer in April rather than March. This would have the effect of reducing the qualifying revenue for March 2020. The application of the anti-avoidance rule would then turn on a purpose test, which depends on the facts and circumstances. There is risk and uncertainty. This could cause some anxiety where any action or inaction causes a decrease in qualifying revenue.
Deeming Rule - Revenue Reduction Condition
If an eligible entity meets the revenue reduction condition for a qualifying period, it would be deemed to meet this condition in respect of the immediately following qualifying period. Since this condition is one of the main obstacles for the subsidy, an entity would probably qualify for two consecutive periods by meeting this condition for the first period. For example, an entity would probably qualify for the first two qualifying periods by meeting the revenue reduction condition for March 2020.
According to an April 16, 2020 news release, online applications for CEWS will be available on April 27. Officials are expecting to process 90% of the claims by May 4 with payments to applicants later during that first week of May. This is great news for many businesses who are eagerly waiting to apply for the 75% wage subsidy under the CEWS program. Businesses and other entities should start assembling information and considering issues relating to the determination of qualifying revenue.