CEWS Formula Penalizes Related Parties Following CRA Guidance

Under new Canada Emergency Wage Subsidy (“CEWS”) legislation, non-arm’s length parties which transact with each other using arm’s length terms – as often required by the Canada Revenue Agency (“CRA”) – are penalized unfairly. This is the result of a definition in the formula which erroneously refers to the “current reference period” when it should refer to the period immediately prior to the “current reference period”. The Government of Canada (which is aware of but has not addressed this issue in its recent legislative updates) should consider revising legislation to put such non-arm’s length companies on equal footing with other CEWS applicants.

Background

The CEWS provides eligible employers with a subsidy of up to 75% of pre-crisis remuneration paid to eligible employees under specific circumstances. One of the requirements for qualifying for the CEWS for a given qualifying period or claim period is that employers show that they have revenue decline in an amount prescribed by statute for the corresponding reference periods. A “current reference period” in 2020 is compared to a “prior reference period” in either 2020 or 2019. For the first three qualifying periods, the required revenue decline is as follows:

Ordinarily, an eligible entity must exclude any revenues received from non-arm’s length sources when calculating “qualifying” revenue decline under new subsection 125.7(1) of the Income Tax Act, R.S.C. 1985, c. 1., 5^th Supp. (“ITA”). A company which earns part of its income from non-arm’s length sources, would completely exclude that revenue from its calculations of revenue decline. The intention appears to be to capture only the entity’s decline in revenue from external sources.

Some companies will not be able to calculate revenue declines using these ordinary rules because they earn almost all of their revenues from non-arm’s length sources. In such cases, a company can elect (under new paragraph 125.7(4)(d) of the ITA) to use a formula (the “NAL Formula”) which attempts to calculate a weighted average of the decline in each non-arm’s length party’s income. An apparent error in this formula puts companies which deal on commercially reasonable, arm’s length terms with related parties at a disadvantage compared to companies which do not deal on such terms.