by: Diane Gaudon, FCPA, FCGA of simplysalestax.com
Canada’s federal sales tax, the goods and services tax (GST) was introduced on January 1, 1991, as the simple tax. GST registrants are often surprised to learn non-compliance issues exist within their business as a result of a GST audit performed by the Canada Revenue Agency (CRA). Due to its complexity, the GST/HST continues to challenge businesses of all sizes. A variety of exposures seem to be consistently identified as problem areas.
Common reasons for failure to remit tax
The failure to remit tax can arise from a variety of situations. One of the most common reasons is a taxpayer’s misinterpretation of what constitutes a taxable supply. Basically, all supplies are taxable unless there is a specific zero-rating provision or exemption applicable. It is a taxpayer’s responsibility to determine whether a supply is taxable or not. When making this determination it is advisable to request a written ruling from the CRA, otherwise, it is recommended that reasoning and backup be retained to support why the supply is not subject to tax in case of an audit.
In other situations, businesses are under-remitting their sales tax because they are charging a tax rate that is too low. The GST place of supply rules are used to determine whether a supply is made in or outside Canada. In addition, when a supply is determined to be made in Canada, then the HST place of supply rules must be used to determine the province of supply. The CRA publication GST/HST Technical Information Bulletin B-103, “Place of Supply Rules for Determining Whether a Supply is made in a Province” provides detailed information and numerous examples to assist in making this determination.
Inter-company transactions are often another area of non-compliance. Taxable supplies of property or services (i.e., management fees) between related companies are generally subject to GST/HST, unless the section 156 election is filed. Since most of these transactions are recorded by a journal entry; the application of sales tax is often overlooked. This is a very easy exposure for an auditor to discover.
Section 156 the Excise Tax Act provides an election for members of a qualifying group to deem most transactions (excluding real property) for Nil consideration (refer to GST Memorandum 14.5). This election has specific conditions that must be met and the election form RC4616 must be filed with the CRA.
Some often-misunderstood GST/HST rules and conditions
The recovery of GST/HST contains numerous rules and conditions that are often misunderstood or ignored. One of the top audit exposures is the input tax credit restriction for meals and entertainment. For income tax purposes, most meals and entertainment expenses are 50% restricted. A similar rule applies for GST purposes, restricting the input tax credit (ITC) to 50% of the GST/HST paid. There are two reporting options available. The first is to restrict the 50% portion of the GST/HST paid on each invoice as it is processed and recorded in the accounting records. Alternatively, a full input tax credit may be claimed throughout the year and at year-end, an adjustment equal to half of all the ITCs claimed must be calculated and clawed back or paid-back to the CRA in the first GST return for the following year. For further information refer to GST/HST Memorandum 8-2, “General Restrictions and Limitations”.
Another exposure related to the recovery of GST/HST involves the numerous conditions that must be met before claiming an input tax credit. Unfortunately, many taxpayers do not realize that these specific conditions even exist.
Mandatory documentation on invoices
One of these conditions is the mandatory documentation requirement. It requires the taxpayer to acquire specific information before claiming an ITC (basically, a supplier invoice with the supplier’s GST registration number printed on the invoice). This information must be retained to support all ITCs claims and for an auditor to review during an audit. The auditor will verify a sample of supplier invoices to ensure that all the required information is stated on the invoice or other supporting information. Frequent audit assessments arise due to missing invoices and the taxpayer’s failure to obtain the supplier’s GST registration number. Further information can be obtained in GST/HST Memorandum 8-1, “General Eligibility Rules”.
Currently, auditors are checking invoices to ensure that the person claiming the ITC is also the person named as the bill to on the invoice or written agreement. Another recovery rule condition requires the recipient of the supply to be named on the invoice as the “bill to” or the person that is liable under that agreement to pay consideration for the supply. Consequently, adequate documentation must be available for an auditor to review during an audit that clearly indicates the person claiming the ITC is the same person liable to pay for that particular invoice.
Verifying amounts calculated by software
It is quite common for a taxpayer’s software to calculate the ITC amount. Exposures can easily occur where these automatically calculated amounts are not verified to the actual amount charged on an invoice. Only the amount actually charged on the invoice may be claimed as an ITC. All excess amounts claimed will be denied during an audit.
Employee expense reimbursements
Employee reimbursements occur when an employer reimburses expenses (e.g. meals, hotels, car rentals, etc.) incurred by employees in the course of their employment. These reimbursements continue to create exposures for taxpayers as they struggle to implement procedures and policies. The biggest problem with expense reimbursements for the employer is obtaining receipts to support the expenses.
There is an administrative policy that allows the employer to choose one of two methods for each expense report category to calculate the ITC. The first method is the Actual Method, which allows the GST/HST paid and shown on the receipt to be claimed as an ITC (subject to meeting the documentation requirements).
The second method is the Simplified Factor Method; this method allows the employer to apply a prescribed factor to the total amount of the expense to determine the ITC. This method relaxes the documentation requirements since a supplier’s GST registration number may be missing but a receipt is still required. The prescribed simplified factors are as follows: British Columbia, Alberta, Saskatchewan, Quebec and Manitoba - 4/104; Nova Scotia, New Brunswick, Newfoundland and Labrador, Prince Edward Island - 14 /114; and Ontario - 12/112.
One method must be selected and applied to each expense report category. The method(s) must be consistently used throughout the fiscal year for all employees. If an employer chooses to apply the Simplified Factor Method for meals and entertainment expenses, the factor method must be used throughout the whole year for all employees and the 50% meals and entertainment restriction will also apply. The employer is required to keep invoices and supporting documentation to support the ITCs claimed regardless of which method is selected (factor or actual). For more information refer to GST Memorandum 9-4, “Reimbursements”.
Taxable benefits and GST/HST
Frequently overlooked is the connection between taxable benefits and the GST/HST. An employer is required to report on an employee’s T4 the full amount of all benefits including sales tax. When a benefit is determined to be a taxable benefit, the employer is also required to determine if sales taxes are applicable and if a sales tax remittance is required. The most common exposure for businesses is the non-remittance of the GST/HST on employer provided vehicles. GST/HST Memorandums 9.1, “Taxable Benefits” and 9.2, “Automobile Benefits” provide additional information.
This is not an exclusive list of exposures; it is only a sample of exposures that auditors typically encounter during a GST audit. For more information about GST/HST visit the CRA website, my website (simplysalestax.com) for tax updates and live monthly webinars on a variety of GST/HST issues, or speak with your accountant or sales tax specialist.
