Sandy runs a business offering an HST exempt service out of an office she rents. The service Jeremy offers is not HST-exempt. Because Jeremy offers a different but complementary service to the public, Sandy suggested that Jeremy offer his service out of Sandy’s office space. To keep the arrangement simple, Sandy suggests that Jeremy pay her 40% of his revenues, and Sandy will provide the office space, supplies, computers, etc. without any further charges. The idea is that Jeremy will just keep 60% of his revenues.
The complication comes with how to handle the HST. Jeremy must charge his clients the HST, but how should it be split between Jeremy and Sandy?
Possibility #1
Sandy only gets 40% of Jeremy’s base rate and gives all of the collected HST money to Jeremy. Jeremy then remits the HST money to the government based on his full revenues (not just the 60% that he actually receives).
Possibility #2
Sandy gets 40% of everything including HST money. Sandy remits her share of the HST money to the government, and Jeremy remits his share. In effect, they are treating it as though Sandy is performing 40% of Jeremy’s service, and Jeremy is performing 60% of it. This feels wrong because it is really Jeremy who is performing the service; Sandy isn’t even qualified to offer Jeremy’s service.
Possibility #3
Sandy gets 40% of everything including HST money because she is effectively charging Jeremy HST on the goods and services she provides to Jeremy. Sandy will remit her share of the HST (less any HST input credits). Jeremy will remit the entire HST amount less the HST input credit from Sandy. This seems wrong because Sandy has charged HST on Jeremy’s rent and possibly other things that HST does not apply to. It also forces Jeremy to use the complex HST accounting instead of the quick method.
I could go on listing different ways to handle the HST in this scenario, but it’s time for others to chime in. What is the correct way to do the HST accounting in this case? Are there any experts out there? Maybe The Blunt Bean Counter?
Update: In a later blog post I explained how to handle the HST for this situation.
I think the problem was right there with "to keep the arrangement simple..." when it's anything but.
ReplyDeleteWhy was 40% chosen? Why on revenue? Is the money flowing through Sandy (i.e., is she handling payment processing for Jeremy?). The straight-off 40% just creates all these questions, and they should probably consider it as something other than a flat percentage first, then work out the percentage they want to use for day-to-day bookkeeping.
Anyway, to me it seems like they're trying to over-complicate it.
At the end of the day, even if Sandy is taking 40% of Jeremy's revenue including HST, Jeremy will be booking the rent expense in (HST-free) dollars. So if Jeremy charges $100 pre-HST, then collects $113 including HST from his clients, whether he gives Sandy $40 or $45.20, it's still not affecting Jeremy's HST obligation. And Sandy's landlording service is likewise unaffected by HST. So they just need to decide on whether the rent will be $40 or $45 for every $100 in pre-HST revenue, and then adjust their back-of-the-napkin 40% accordingly for the HST-included revenues.
Then on top of that, Sandy is also offering an office supply/computer rental service, which would likely not fall under her HST-exempt status. It gets quite complicated then to charge Jeremy for HST on that service, pro-rate her own supplies for that, etc. If it's a small portion of her own business' usage, then it may be best to just do it under the table, and count the whole payment as rent. If not, well, then they have to decide how much of the 40% is rent and how much is for the use of office supplies and equipment.
@Potato: I agree that this arrangement creates hidden complexity. If I understand you correctly, you think that Jeremy must declare the entire HST amount, possibly reducing it by HST inputs from paying Sandy. This seems right to me, because if it were possible to divide up both Jeremy's revenues multiple ways so that all shares were under the threshold for charging HST at all, Jeremy could avoid the HST entirely.
ReplyDeleteYep. Also consider it another way: if I spend all my income, it doesn't affect my income tax obligation, even if I have my employer take it off the top for transit passes or parking or merchandise credits.
ReplyDeleteSo the only way that the arrangement with Sandy would change Jeremy's HST would be something like #2 where she's considered a partner performing 40% of the work -- which creates a whole new set of headaches in setting up a partnership, possible liability for Jeremy's work, etc.