The HST Blog : Canada Harmonized Sales Tax Lawyer Cyndee Todgham Cherniak for Assessments, PST & RST Issues in Ontario, British Columbia & Quebec

Some companies/businesses are very compliance-conscious when it comes to sales tax.  They attempt to do everything by the book.  However, with the changes to harmonized sales tax and the late breaking changes to the sales tax laws, some issues may have fallen through the cracks.

Other companies have hired experienced sales tax staff to ensure accounting records are accurate and GST/HST returns are filed on time.  But, these employees deserve their 4 weeks vacation or have sick days from time to time.  Someone else takes over their desk and mistakes can occur.

Some companies conduct internal audits of their sales tax reporting mechanisms every year.  When such mistakes are discovered, the entity may make be able to make adjusting entries (such as claiming an overlooked input tax credit) or may file an amended return (if permitted to adjust the amount of GST/HST collected).  However, when the mistakes are discovered later in time or are systemic in nature or are the result of changes to the law that were not understood in time, it may be necessary for the company to make a voluntary disclosure.

A voluntary disclosure must be made before the tax authorities come knocking on your door.  If the tax authorities are already planning an audit, they may not accept any disclosure as voluntary in nature.

A voluntary disclosure must be complete and may be subject to an audit.  Think of a voluntary disclosure as you doing the auditor's job for them.  You do the calculations that they would do if they came in to conduct an audit.  By taking this approach, if the tax authorities decide to verify your voluntary disclosure, they can quickly determine that you have been as thorough as they would have been.

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Robert H. Jackson once wrote that:

"The United States has a system of taxation by confession. That a people so numerous, scattered and individualistic annually assesses itself with a tax liability, often in highly burdensome amounts, is a reassuring sign of the stability and vitality of our system of self-government. What surprised me in once trying to help administer these laws was not to discover examples of recalcitrance, fraud or self-serving mistakes in reporting, but to discover that such derelictions were so few. It will be a sad day for the revenues if the good will of the people toward their taxing system is frittered away in efforts to accomplish by taxation moral reforms that cannot be accomplished by direct legislation. But the evil that can come from this statute will probably soon make itself manifest to Congress. The evil of a judicial decision impairing the legitimate taxing power by extreme constitutional interpretations might not be transient. Even though this statute approaches the fair limits of constitutionality, I join the decision of the Court.”

United States v. Kahriger, 354 U.S. 22 (1953)

I think of this passage when I ponder some of the new and very complex rules relating to financial services, financial institutions, "arranging for" and pensions under the Excise Tax Act (Canada). As the insightful Justice Jackson has pointed out, the voluntary reporting regime is undermined when good companies who want to comply cannot.

The words of Justice Jackson may be repeated in Canada and in the context of sales taxes because the GST/HST regime involves self-reporting.  I am just saying ...

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Non-residents businesses may be entitled to recover GST/HST paid on goods delivered in Canada if the goods are exported within 60 days and if they file the paperwork for a refund/rebate. Generally speaking, non-resident consumers are not able to recover GST/HST paid on goods purchased in Canada. Canada does not have a VAT rebate for visitors who purchase goods.

Non-resident businesses who purchase goods in Canada and arrange for delivery in Canada would complete the general refund application form GST189 to claim a refund.  The rebate ismailed to the Canada Revenue Agency and not handed to the supplier for immediate benefit.

If the non-resident business or consumer allowed the supplier to arrange for shipping of the goods so that the delivery of the goods occurs outside Canada, GST/HST would not be charged.  If goods are delivered in Canada, the supplier must charge the GST/HST because the supplier can no longer control whether the goods actually leave Canada.  I had a case once where the CRA officer said to me 'How do I know that your client did not stop while driving to the United States at a few spots to resell the goods within Canada?'  The reality was, it would be difficult to prove the officer was wrong.

So here are a few examples:

If a non-resident individual comes to Canada and buys clothes and takes delivery at the store, he/she would pay GST/HST to the store and would not recover the GST/HST by way of a rebate.  If that same individual arranges for the store to ship the goods outside Canada, then GST/HST would not be payable.

If a non-resident business purchases clothes from a Canadian manufacturer to be delivered in Canada, exports the goods so that they can be resold outside Canada, the business would pay GST/HST to the Canadian manufacturer and file a rebate claim so long as the goods were exported within 60 days. If the non-resident business purchases clothes from a Canadian manufacturer to be delivered outside Canada (the manufacturer arranges the shipping), the non-resident should not pay GST/HST to the Canadian manufacturer as the transaction is zero-rated.  The non-resident saves the cash flow costs by paying for the manufacturer to ship the goods.

If a non-resident person purchases a classic car at an auction in Canada for the purposes of reselling the car at a later point in time (an adventure or concern in the nature of trade), he/she may claim a refund/rebate if the car is delivered in Canada and GST/HST is paid to the vendor of the car.  If the non-resident purchases classic car to be delivered outside Canada (the supplier arranges the shipping), the non-resident should not pay GST/HST to the Canadian supplier as the transaction is zero-rated. 

If a non-resident takes possession of goods in Canada and plans to export goods and file for a rebate, they must prove that they exported with goods within 60 days.  That means they need paperwork that has been stamped by government authorities relating to the export.  It used to be that the non-resident would present themselves and the goods to the Canada Border Services Agency (CBSA) at the time of export and complete paperwork.  The CBSA says to non-residents that they do not have forms to complete relating to exports (even though there is the E15 Certificate of Destruction/Exportation).  I recommend that the non-resident prepares paperwork and ask the CBSA to stamp the paperwork to acknowledge the request (at least). More importantly, the non-resident should complete the entry paperwork when returning to their home country.  In the United States, the person would complete a form 7901.  This paperwork is good evidence of an import into another country, which usually is accepted as evidence of export from Canada. 

It may take weeks or months to receive the refund/rebate cheque in the mail.  There is an interesting case of a non-resident purchasing a plane and hitting a bird on take-off and having to complete repairs before export.  It took longer than 60 days to repair the plane, the 60 day deadline was missed and the rebate claim was denied by the Canada Revenue Agency and the Tax Court of Canada.

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I was asked the following question:

Hi, what if I initially thought that I would not be doing $30,000 worth of business and therefore, did not charge the HST.  Then part way through the year, I get a surprise project that puts me over the $30,000 limit.  Do I then just start charging the HST, or, would I need to re-invoice the other clients for the HST amount?

The answer is that you must register for GST/HST purposes when you take on the project that will cause you to exceed the small supplier threshold. After you are registered for GST/HST purposes, you must invoice GST/HST where applicable on invoices issued after that date.  Unless you retroactively register for GST/HST purposes, you would not re-issue old invoices issued before the date of registration.

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The services of an employee (a real employee) are not subject to goods and services tax ("GST") or harmonized sales tax ("HST").  The services of an independent contractor are subject to GST/HST if that person is not a small supplier.  A small supplier is a person who makes less than $30,000 per year - they do not need to register for GST/HST purposes and are not required to charge, collect and remit GST/HST.

Persons who are independent contractors and who make supplies that exceed $30,000 per year must register for GST/HST purposes and charge, collect and remit GST/HST.  This would include service providers from outside Canada who come to Canada to perform services. 

Persons who hire independent contractors must pay the GST/HST on the services.  If the person is engaged in exempt activities, they may not be able to recover the GST/HST paid to the independent contractor.  As a result, the GST/HST can represent an increase in the cost of the services.  If the person is engaged in commercial activities, the person may be assessed for failure to pay GST/HST if the independent contractor does not charge GST/HST when required. As a result, the business must be a watchdog in this area.

With the implementation of HST, the distinction between employees and independent contractors has become more important.  If a business wants a person to be an employee, they need to document the employment arrangement and make all necessary source deductions.  If a business wants a person to be an independent contractor, they should review income tax case law to ensure that the person meets the factual requirements associated with an independent service provider.  For example, an independent contractor uses his own tools to perform his/her trade. 

This area is more complicated than it seems.  Depending on the amounts at issue, it may be worth taking some time to structure the arrangements more carefully and clearly.

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Recently, I was called in to assist a vendor who had a visit from an Ontario retail sales tax ("ORST") auditor on a Tuesday and the auditor indicated that the assessment would be issued on Wednesday.  What was different about this audit was that the issues were complex and it was so very quick. A year ago, this audit would have taken months to complete.  A year ago, the auditor would give the vendor time to review an audit assessment before pushing the "issue assessment" button.  A year ago, the auditor would have allowed the complex issues to be debated and possibly would have requested guidance from tax advisory on the complex issues.  Not this year ....

What was different is that this auditor had arrived with the conclusions already formed.  This meant two things: (1) the auditor was targeting a specific type of business and had seen the issue before, and (2) the auditor was rushing quickly through a list of targets.

What is different is that ORST auditors move to the Canada Revenue Agency in March 2012 and have to complete all remaining audits before they move jobs.  Auditors do not have the luxury of time because the clock is ticking.

Ontario businesses need to prepare for audits and call in specialists earlier - procrastination is no longer an option.  Vendors may not have time to find an ORST specialist and canvass the issues in the period between the auditor's initial visit and the auditor pressing the "issue assessment" button.  Specialists may not be able to run to a vendor's aid on short notice.

Once an assessment is issued, the assessed person must file a notice of objection in order to dispute the amount assessed.  More importantly, the assessed person must pay 100% of the assessment immediately or according to a payment schedule arranged with the Ministry of Revenue.  Even more importantly, it takes over 2 years for an appeals officer to review an ORST notice of assessment and even longer to make a decision.  I have a notice of assessment filed in 2007 that has not been dealt with yet by the Ministry.  If the issues are complex, the assessment may be confirmed at the appeals stage and the assessed person must go to court to get the money back.

ORST audits are different in this final rush to close the books.  Vendors who do not realize that things have changed may be surprised.  Vendors who have not yet been audited, should expect a visit from an auditor.  They should also plan ahead if they want to limit the negative effects of the audit.

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I have seen an increase in Regulation 105 withholding tax audits recently and non-residents registered for GST/HST are affected.  The withholding tax audits are usually audits of Canadian companies who make payments to non-resident suppliers (often from the United States).  The cases I have seen recently involve a non-resident who provides services to the Canadian company at the a Canadian location.  Often, the contract calls for the Canadian company to reimburse the non-resident supplier for expenses incurred during the delivery of the services (e.g., the travel costs).  More recently, the Canadian business asks the non-resident to register for GST/HST purposes so that the non-resident can remove imbedded GST/HST in the agreed disbursements. With the implementation of HST, the disbursement costs have increased.  When the non-resident voluntarily registered for GST/HST, they checked the box on the registration form that they are carrying on business in Canada.

In many cases, when a Canadian business pays an amount to a non-resident business, the Canadian business must withhold a percentage specified in an tax treaty (the withholding tax) and remit that amount to the Canada Revenue Agency.  For example, if a U.S. company provides services to a Canadian company, the withholding tax rate would be 15%.  The Canadian business provides the non-resident with the requisite forms and the non-resident takes steps to get the money back from the Canadian Government. It is beyond the scope of this blog posting to cover all the withholding tax rates of Canada and all the exceptions and the steps to pay and recover withholding tax.  What is clear is that many Canadian companies do not withhold and get audited and assessed.

My reason for posting this blog article is to communicate to non-residents that the administrative task of completing a GST/HST registration form establishes a paper trail for non-residents and a simple answer relating to one Canadian tax may result in non-so-simple issues regarding another Canadian tax.  Please ask questions of an experienced Canadian tax lawyer.

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The Ontario Ministry of Revenue conducts audits of vendors (sales side audits) looking for failures to remit tax collected and failures to collect tax.  The Ministry also conducts audits of purchasers (some are also vendors) looking for failures to pay tax on taxable goods (called purchase side audits).  When an auditor is looking at the purchase side of the business and failures to pay Ontario retail sales tax ("ORST"), the best defense is that "The other guy was audited already or self-assessed the ORST - you have your money".

The Ministry should not audit both the vendor and the purchaser for the exact same tax.  This happens sometimes because an audit or a purchaser can lead to an audit or a vendor and vice versa because an audit brings out information of non-compliance of others. Often the auditor goes from an audit of one person to his/her next "target" who was discovered in a previous audit.  Many times the auditor may not know of the other audit/assessment.  It should not be assumed that the auditor is intentionally trying to collect the same tax twice.

Over the course of my career, I have helped many businesses during the audit process by asking them to review an audit summary (before the "finish assessment" button is pushed) and identify large amounts of unpaid ORST on the purchase side of the audit.  I explain that the Ministry cannot assess the same tax twice.  If they have good relationships with their suppliers, I explain the benefits of picking up the phone and calling their contact at a supplier to see if they have been visited by an ORST auditor.  Sometimes the answer is "unfortunately, yes" and sometimes the answer is "luckily, no".

If they answer is "unfortunately, yes", it will be necessary to determine if the transactions at issue in the current audit were covered by the other audit and assessment.  If the answer is "yes", then the auditor should remove those items from the proposed assessment before pressing the 'finish assessment" button on the computer (there really isn't such a button).

Even if the answer is "luckily, no", the supplier may have self-assessed if they determined they should have charged and collected the ORST.  The supplier could have made a voluntary disclosure or received advice from an accountant or lawyer and the ORST could have been remitted without the purchaser knowing or receiving a new invoice showing ORST remitted/remittable.

It is worth mentioning that the vendors may use this defense if a purchaser has voluntarily disclosed or self-assessed and remitted ORST or if the purchaser has been audited.  The vendor may show an auditor that the ORST has been remitted or paid to the Ministry of Revenue in order to defend portions of a sales side audit.

The next step after finding that "the other guy has paid or remitted the ORST" is to communicate the information to the auditor and providing adequate proof that the monies have been paid.  This is where an experienced lawyer may be able to help with the clear communications and strategy. 

The existence of this defense is important to know now more than ever before because Ontario is auditing in order to finish all ORST audits by March 2012 (when the auditors transfer to the Canada Revenue Agency).  There is an increased likelihood that this defense is available given the volume of audits.

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When a lawyer or accountant discovers that a client has made an error (e.g., treated certain sales as tax exempt when they are actually taxable), they may recommend that the client make a voluntary disclosure.  Assuming that the disclosure meets the administrative criteria of the tax authority as being voluntary (which is an entirely other problem), the hard part is "getting to 'Yes' with the auditor".

The voluntary disclosure must be complete and accurate.  The auditor operates under the mantra "accept, but verify".  If the person making the disclosure leaves out important information that they do not want the auditor to know, they may be fooling themselves and not the auditor.  The auditor may discover those secrets during a desk audit or an on-site audit.  The factual circumstances may not make sense to the auditor if part of the story is missing and the auditor will dig further. Do not assume that the auditor will accept the cheque on behalf of the government and not have a single follow-up question.  That never happens.

When a business makes a voluntary disclosure, they often do so to avoid paying the penalty that is charged when an auditor finds the mistake. In return for not charging the penalty, the government wants a complete and accurate disclosure of the relevant facts in order to be in a position to determine that the business is coming in to full compliance.  Essentially, in a voluntary disclosure, you do the work for the auditor and the auditor quickly reviews the work (and in the case of correct disclosures, simply agrees with your worksheets).

Voluntary disclosures can be problematic when this simple review stage cannot take place because the information is not provided.  In many cases of voluntary disclosures by inexperienced persons, there is no intentional wrongdoing, but the disclosure is not complete because of the inexperience.  The auditor wants certain information and if the person making the disclosure does not understand the task at hand, or the sales tax regime, or the facts that are relevant or the documentation that will be relevant, etc., the good intentions of the voluntary disclosure can turn into a big and costly mess.

It is kind of like that home renovation project that started with a beautiful photo in a magazine and when you did it yourself to save money, it ended really badly and was much more expensive.  Or, you hired a cheap contractor who did not have experience renovating bathrooms, but took on the project, and ran into problem after problem after the demolition phase.  Part way through the project, you could not turn back and go back to the status quo.

Consider sales tax specialists as a "Mike Holmes" of voluntary disclosures.  Professionals who have done this before plan ahead.  They use their knowledge to investigate the potential issues BEFORE moving forward with the project.  They develop a plan that is tried and true.  They help you be reasonable in your expectations.  They work with you so that the results are successful and within the planned budget.

Many sales tax lawyers who have helped many clients make voluntary disclosures have precedents that they use to prepare the voluntary disclosure.  They know the statutory provisions, the case law, and the tax advisory opinions that apply.  Sales tax lawyers are able to help you gather the facts and communicate the facts correctly.  They can anticipate the follow-up questions and include the answers in the disclosure.  They can help you organize the applicable documents and the documents that the auditor likes to review in the normal course. 

Getting to "yes" in a voluntary disclosure means meeting the auditor's expectations and needs.  The auditor must put together a report for a supervisor.  You must give the auditor what he/she needs to get that approval.

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