Common GST/HST exposure areas
(As originally published in FEI Canada F.A.R. member e-newsletter, November 2012)
By Alicia Lennon, Manager, Indirect Tax, and Mary Anne McMahon, National Advisor, Ernst & Young LLP
It has been over twenty years since the Goods and Services Tax (GST) was introduced in Canada, to be followed in subsequent years with the Harmonized Sales Tax (HST) in participating provinces. Yet many businesses continue to struggle with the implementation of effective processes to manage the complexities surrounding indirect taxes. Certain issues are consistently identified as problem areas for organizations, with the potential to become significant tax exposures. Some of the more common problem areas are outlined in this article.
The indirect tax landscape in Canada is constantly changing. Organizations must keep an ear to the ground so that they are prepared to adapt to the myriad of legislative changes which come their way. Some significant upcoming changes include:
- British Columbia will effectively "de-harmonize" as of 1 April 2013. The GST will continue to apply but the Provincial Sales Tax (PST) will be reinstated at the rate of 7%, on essentially the same basis on which it applied prior to harmonization.
- Prince Edward Island announced it will also join the ranks of the participating provinces by harmonizing its existing 10% PST with the GST, and will be implementing a new HST rate of 14% on 1 April 2013.
- Finally, effective 1 January 2013, there will be a quasi-harmonization of the Quebec Sales Tax (QST) with the GST. Among the many changes that will take effect, one of the most notable will be that GST will no longer be included in the base on which QST applies. The fully-harmonized QST will apply at a rate of 9.975% (in addition to the 5% GST). There will also be a significant change for financial institutions, whose financial services will change from zero-rated to exempt status and thus put an end to the recoverability of QST paid on purchases of goods and services for most financial institutions. The QST will continue to be administered by Revenu Quebec (RQ).
Input Tax Credit Documentation
An area coming under increasing scrutiny by Canada Revenue Agency (CRA) and RQ in their audits is adequate documentation for input tax credits (ITCs) and/or input tax refunds (ITRs).
In addition to ensuring that the GST/HST and QST registration numbers of the supplier are obtained by the recipient of the supply, the numbers must also be valid. Government authorities are carefully checking to see whether the party claiming the ITC or ITR is the party named on the invoice or written agreement. To be eligible to claim ITCs or ITRs, a party must be the recipient of the supply.
The recipient of a supply is generally the person who enters into the agreement to acquire the property or service, and is therefore, liable under that agreement to pay consideration for the supply. Adequate documentation to demonstrate that a registrant is the recipient of the supply could include an agreement or invoice with the name of the registrant clearly indicated.
Failure to meet the documentary requirements for an ITC and/or ITR can result in the amounts being denied.
Taxable supplies made between related parties are subject to GST/HST unless the parties have made an election to treat them as being made for nil consideration, or as exempt supplies.
In many cases, it is not until an entity is under audit that it realizes it is offside in the GST/HST treatment of related party transactions – parties often act as if an election was in place, where no election is made. It is critical that entities ensure they meet the eligibility criteria for the election, that an election be jointly-made (and adequate documentation is maintained on file), and that the election provides sufficient details concerning the types of supplies being made between the parties. Where no election is made or is available, GST/HST should be collected on related party transactions as necessary.
Taxes on insurance
Many companies are unaware of the Canadian tax consequences arising from insurance policies purchased outside of Canada or outside of the province where the risk is situated. Depending on the location of the risk, taxes imposed on insurance premiums can easily increase the cost of insurance by 20% or more, over and above the cost of the premium. Most at risk are global corporate organizations that have purchased insurance policies from offshore insurers on behalf of their branches or subsidiaries in Canada, and who then allocate premiums to those branches and subsidiaries.
A federal excise tax of 10% is levied across Canada under Part I of the Act on premiums for insurance policies that cover risks within Canada, where the insurance is purchased from a non-Canadian insurer who is unauthorized under Canadian or provincial law, or where the insurer is authorized, but the contract of insurance is entered into through a non-Canadian broker.
In addition to the federal tax, some provinces such as Ontario, Quebec and Manitoba also implement sales taxes on insurance. Additionally, under certain circumstances, many provinces including Ontario, Quebec, British Columbia, Alberta and Saskatchewan impose premiums taxes on particular types of insurance.
Are you a de minimus financial institution?
When we think of financial institutions, we typically think of banks, insurance companies, and investment plans. These types of financial institutions are defined as “listed financial institutions” for purposes of the Act. However, certain commercial enterprises (those predominately making taxable supplies in the course of a business as opposed to exempt supplies of financial services) can also be financial institutions. Commercial enterprises that earn a significant portion of their income from financial services, such as interest income, may qualify as a "de minimus" financial institution for purposes of the Act.
There are a number of consequences that result from qualifying as a de minimus financial institution. These may include a requirement to file annual information returns and changes in the way the entity collects tax. The manner in which ITCs are claimed could also change because de minimus financial institutions are required to comply with the special ITC apportionment rules.
Indirect taxes are often taken for granted, but the potential for exposure can be significant. Businesses can reap real benefits by vigilantly monitoring legislative and/or policy changes, and ensuring effective processes and controls are in place to provide for full compliance with indirect tax rules and regulations.