Indirect tax opportunities in a precarious economic context
An overview of GST/HST and PST relief and opportunities under the current pandemic, from the Tax Group of the Montreal office of McCarthy Tétrault LLP
Left to right: Nicolas Désy, partner; Kassandra Grenier, associate; and Fred Purkey, partner, of the Tax Group in the Montreal office of McCarthy Tétrault LLP.
MONTREAL – For the last several months, the global economy has been, and at the time of writing remains, disrupted by the rapid spread of the COVID-19 pandemic. A very large number of businesses operating in various sectors of activity have taken drastic measures in order to survive this crisis.
Many relief measures have been implemented by various levels of governments in Canada to stabilize the Canadian economy during these difficult times. The purpose of this publication is not to present these various programs, the details of which can be found here, but rather to provide an overview of some of the relief and opportunities existing under the goods and services tax/harmonized sales tax ("GST/HST") and provincial sales tax ("PST") regimes for the current circumstances. Taking into account such potential relief, we strongly encourage registrants to carefully review their sales tax process and the implications on their transactions to maximize cash flow and input tax credits/refunds ("ITC/ITR") claims.
Since the Quebec sales tax ("QST") rules are largely harmonized with those of the GST/HST, we will only refer to the provisions of the Excise Tax Act (Canada) ("ETA") in this publication, unless otherwise indicated.
1. Bad Debts
Under the GST/HST regime, a supplier may claim a deduction in determining the net tax for GST/HST charged and remitted, but not collected from its arm's length client. This is the case where all or part of the consideration of the supply and the corresponding GST/HST has become a bad debt and has been written off from the supplier's books and records.1
What is a bad debt? The determination of a debt as a "bad debt" is essentially a question of fact and is based on the relevant circumstances of each case. The administrative position of the tax authorities provides that the applicable accounting principles and certain factors such as the time elapsed since the due date for payment of the debt, the debtor's financial condition and the debtor's account history should be considered when making this qualification.2
Hence, this is an immediate cost-saving measure for the registrant because of the deduction from net tax it can claim in its GST/HST return corresponding to the time the debt is written off.3 In these difficult times, we strongly recommend that all registrants review their receivables management processes, specifically to determine whether opportunities for deduction in calculating the net tax exist or have been ignored in respect of bad debts.
Similar rules may apply in the PST regime of British Columbia, Manitoba and Saskatchewan, with the necessary adjustments and particular circumstances of each case.
Other alternative? Provided that all the conditions required to write off a debt are not met, a registered supplier could also reduce the consideration initially invoiced to its client by issuing a credit note containing the prescribed information.4 The supplier would then be entitled to claim a deduction in determining the net tax for the reporting period in which it issues the credit note.
2. Accounts Receivable and Payable
This is a relatively simple strategy which may help accelerating ITC claims and the collection of the GST/HST to improve cash flow savings.
Accounts receivable Generally, where a registrant has a monthly reporting period, the GST/HST charged must be remitted by the end of the month following the month in which the GST/HST was billed. In practice, however, accounts receivable are frequently not collected for several weeks or even, several months, thereby creating a negative impact on the registrant's cash flow, because it is required to remit the GST/HST billed even before it collects it from its client. The review of the accounts receivable billing process to issue invoices at the beginning of each month or entering into payment terms with clients could therefore shorten the elapsed time between the moment where the GST/HST billed has to be remitted and when it is actually received.5 Delaying the issuance of an invoice by a few days may make a difference.
Accounts payable In a context where the registrant's accounting period is closed and its monthly reporting period has ended, the registrant should still take the time to analyze the invoices payable received before the end of each month since it may be entitled to claim ITCs in respect of invoices dated before the end of the reporting period, even if they have not yet been paid. Indeed, the registrant may claim an ITC for a reporting period in which the GST/HST in respect of the supply became "payable" (assuming all other documentation requirements have been met to make such claim).6 In general, the GST/HST is deemed payable on the day an invoice is issued to the registrant.7 As a result, ITCs can be claimed more quickly through this mechanism, thereby optimizing cash flow. Here again, payment or invoice issuance terms may be negotiated with a supplier and receiving an invoice a few days earlier may make a difference.
3. Indemnity Payments
Where at any time, as a result of the breach, modification or termination of an agreement for the making of a taxable supply by a registrant to a person, an amount is paid otherwise than as consideration for a taxable supply, the GST/HST may be deemed to be included in this amount. In this case, the supplier is deemed to have collected such GST/HST and the person is deemed to have paid it.8 This mechanism applies similarly in the event a debt, or other obligation, of the supplier is reduced or extinguished without payment on account of the debt or obligation. For example, this rule could apply to contract cancellation fees, lease cancellation fees or any other compensation costs payable for breaches of agreements.
This is a presumption of automatic application that is often forgotten or even misunderstood in practice by many registrants. It allows the recipient-payor to claim an ITC for the portion of the GST/HST deemed to be included in the payment made to the supplier for compensation or indemnification purposes. In the current context, it would be a good timing to review agreements, including transactions and settlement arrangements, and the obligations of the parties arising therefrom to maximize ITC claims in respect of payments made of this kind or, conversely, to ensure that the compensation to be received by the supplier is enhanced to take into account the GST/HST deemed included in such compensation and avoid a significant loss for the supplier.
4. Intercompany Transactions
A very simple way to improve cash flow within a corporate group is to make the joint election to have certain taxable supplies made between "closely related" Canadian corporations or partnerships to take place without GST/HST.9 This election may apply in respect of both GST/HST and QST, or only in respect of GST/HST or QST, and is effective as of the date indicated on the election form.10
Another option, again rarely used in practice, is the joint election to permit set-off of GST/HST refunds or rebates against GST/HST owing between corporations that are members of a closely related group.11 Provided certain prescribed conditions are met, rebates or refunds to which one member of the group is entitled to may reduce or offset certain amounts remittable or owing by another group member, including net GST/HST and GST/HST payable in respect of self-assessments in relation to taxable supplies of real property. This election is unfortunately not available for partnerships and does not allow to offset the GST/HST with the QST, and vice versa.
5. A Few More Opportunities
Customs and GST on imports Many changes, including the introduction of protectionist measures and new free trade agreements, have occurred in recent months with respect to international trade. These changes could give rise to opportunities of refunds of import GST or duty rights in certain situations. Under the ETA, there are, among other things, various mechanisms for claiming the GST on importations. Businesses should therefore conduct a due diligence review of the impact of these new rules on their commercial transactions.
GST/HST paid in error In certain circumstances, such as when the wrong tax rate has been applied or when a supplier is not inclined to refund or credit its client for tax billed in error, it is possible for the person who paid or remitted such amount on account for the GST/HST to claim the refund directly from the tax authorities. This request must be made within two (2) years after the day the amount was paid.
Unclaimed ITCs/ITRs and restrictions for "large businesses" Generally, a registrant has four (4) years to claim corresponding ITCs for the GST/HST paid or that became payable in respect of purchases of property and services acquired for consumption, use or supply in the course of its commercial activities. A diligent review of a business' various accounts might be of interest if the business has not maximized its ITC/ITR claims in recent years.
For example, as of January 1, 2018, "large businesses" can claim ITRs for a portion of the QST paid or that became payable on restricted expenses of goods and services at a rate of: (i) 25% for the year 2018; (ii) 50% for the year 2019; (iii) 75% for the year 2020; and (iv) 100% for the year 2021 and the years following. On the other hand, these restrictions have never been applicable in respect of electricity, gas, combustibles and steam used in the production of movable property intended for sale nor with respect to supplies of food, beverage and entertainment, the deductibility of which is not limited to 50% under the Taxation Act. In addition, the reimbursement of certain employee expenses and allowances may rise to ITCs/ITRs for registrants incurring such expenses.
PST of British Columbia, Manitoba and Saskatchewan The GST/HST is a value-added tax that is, subject to certain exceptions, levied on all transactions made in the commercial chain. It is recoverable through the ITC mechanism. In contrast, the PST is a sales and use tax intended solely to tax retail sales made to the final consumer. The PST is a non-recoverable tax which constitutes a direct cost for businesses who have to pay it in the course of their commercial activities. Therefore the PST provides a series of specific exemptions for supplies made in the course of commercial activities.
Businesses should consider carefully the application of PST before paying it since several exemptions may apply based on (i) the use of the property (e.g. production and manufacturing or purchase for resale), (ii) the nature of the property (drugs, food, etc.), and (iii) the purchaser's identity. In practice, PST is frequently charged in error or overpaid.
Tax on insurance premiums and fuel taxes In general terms, the payment of these taxes is not recoverable, unlike the GST/HST. However, the use of fuel in certain context may qualify for exemptions. Certain insurance premiums may not be subject to Canadian excise taxes. Once again, it is important to assess the application of such taxes before paying them..Sophisticated data analytics and artificial intelligence tools paired with sales tax knowledge and expertise can help to quickly and efficiently identify the opportunities set-out above. Considering the lack of time and resources to dig into such cash-flow optimization and net refund opportunities, it can become interesting for businesses to rely on such tools, especially in the current economical context.We are here to help you in connection with any indirect tax matter and can accompany you to identify opportunities and optimize cash-flow in relation to indirect taxes.