Restricted and recaptured input tax credits
One of the most common errors is neglecting to restrict the 50% recovery of GST/HST on reimbursements of meals and entertainment expenses incurred by employees. This process became more complex with the 1 July 2010 harmonization of sales taxes in Ontario and British Columbia, where, in addition to restricting 50% of the HST paid for federal purposes, large businesses must generally recapture and report separately the provincial portion of the HST, subject to certain exceptions.
There is no recapture of the provincial component of HST to consider in the harmonized Atlantic provinces.
Full input tax credits (ITCs) can be claimed on a monthly basis, with a recapture calculation performed at year end. This recapture calculation can become complex in cases where purchases are made in several provinces with different GST/HST rates. The year-end adjustment can easily be overlooked, so many businesses prefer to restrict the 50% throughout the year.
Determining the HST recapture amount for meals and entertainment is often approached incorrectly. It is important to multiply the total amount of ITC to which a business is entitled by 50% before calculating the 7/12th or 8/13th provincial component that is subject to recapture. Doing otherwise results in reporting double the amount of recapture for BC or Ontario. Even though the net GST/HST payable will remain unchanged, those errors are subject to reassessment.
In addition to meals and entertainment expenses, the provincial recapture provisions in Ontario and BC extend to telecommunication services, the purchase or lease of a licensed road vehicle weighing less than 3,000 kg, and energy not used in manufacturing or farming.
ITC recapture applies to gasoline for licensed road vehicles in Ontario (BC has a point-of-sale rebate, so the provincial component is not paid). A gradual phase-out of the recapture requirements is scheduled to begin on 1 July 2015 and continue to 1 July 2018, when all the tax will be recoverable.
These recapture items mirror Quebec’s input tax refund restrictions for large businesses for the same categories of expenses, including fuel. Many organizations face challenges with capturing these restrictions and many QST assessments arise as a result.
In addition, no ITC is available for GST/HST paid on membership fees or club dues when their main purpose is to provide dining or recreational facilities. However, if expenses are incurred at these clubs for meals and entertainment, the tax is recoverable, subject to the restrictions noted above.
To recover GST/HST paid to suppliers, businesses are required to have sufficient documentation on hand (e.g., a valid GST registration number matching the supplier, among other things) prior to claiming an ITC.
The Canada Revenue Agency (CRA) has a website where a GST/HST registration number can be validated. Documentation should also show the vendor’s name (especially the correct legal entity), a description of the goods being purchased, the payment terms, the amount payable for the supply and the total amount of GST/HST applicable to the sale. It is important to note that the input tax credit to recover the GST/HST may be claimed only by the recipient of the supply — that is, the person who is legally liable to pay for the supply.
While businesses will periodically write off small, uncollectible account balances from their books and impute an amount as being GST/HST, the CRA requires that all or part of the consideration and tax in respect of the supply must have become bad, and the supplier is able to recover the tax only in proportion to the unpaid balance. Therefore, in circumstances where an invoice has been short-paid by only the amount of tax, for example, only a pro-rated component of the short-paid amount may be recovered. In addition, if an amount that was written-off as a bad debt is subsequently recovered, and the supplier reduced its net tax owing at the time of the write-off, the supplier must remit to the CRA the tax component of the amount recovered.
Rates of tax
The transition to the new HST place of supply rules in 2010 continues to present challenges for organizations, especially for determining the tax rate applicable to services. The applicable tax rates for services in Canada now follow a general rule: the tax rate is determined based on the customer’s business address, so it’s important that registrants update their customer master profiles to ensure the appropriate rate of tax is collected. There are several exceptions to the general rule, so careful attention is required for each type of transaction.
The applicable tax rate for goods delivered in Canada is generally dependent on where the goods are actually delivered. However, in cases where documentation shows that goods are delivered to a customer at its supplier’s dock, but the vendor has contracted with a carrier to deliver the goods to another province, the tax rate of the destination province will apply rather than the tax rate of the province where the document states the delivery occurs.
It’s common for businesses to make intercompany charges by way of journal entry without an invoice and not account for GST/HST as part of the entry. It’s important that the appropriate elections be made or on file, as the case may be, not to collect GST/HST on taxable intercompany supplies. Although there may be no net tax loss to the CRA, an auditor may raise an assessment for the incorrect reporting.
In cases where goods are imported into Canada, a broker’s invoice is issued showing the duty paid and any related taxes. Occasionally, only the amount of GST/HST charged on the broker’s fee will be claimed as an ITC, leaving what normally is a far larger amount of tax on the duty-paid value of the imported goods unrecovered. For some businesses, these amounts can be significant, so it’s important that attention be paid to these invoices to ensure that the correct amounts are recorded as input tax credits.
Accounting for GST/HST
When a GST/HST return is completed, incorrect amounts are often reported on the return. To help reduce this error, it can be helpful to record GST/HST collected from customers in a separate GST/HST payable account, all amounts paid to suppliers in a GST/HST recoverable account and all recaptured amounts in separate accounts by province. Provided these amounts are reported as such and the accounts are reconciled each month, there should be less confusion as to the correct amount that needs to be remitted or recovered.
Everyone involved in your organization’s commodity tax processes — from billing and accounts payable to invoice approval and internal audit — should know about the relevant rules. That will help relieve the anxiety around a commodity tax audit and reduce the potential for an assessment.
With so many obligations and recent changes to the rules, it’s also prudent to have training and other learning resources available to help your people navigate the complex issues.