By: Bobby B. Solhi, J.D. and Alexander Yu
The Canada Revenue Agency (CRA) is again focusing its audit activities on cross-border transactions. The CRA audits have focused on the GST/HST implication of such transactions where a number of companies involved in the import or export of goods and services have seen their claims for input tax credits denied for various reasons.
We have outlined four key areas in the GST/HST regime in respect of cross-border transactions so as to avoid adverse customs and GST/HST implications.
Recovering the GST/HST
Goods and services which are imported into Canada are generally subject to the Goods and Services Tax/Harmonized Sales Tax (GST/HST). These are usually recoverable amounts to the importer or beneficial in the follow manner:
Input Tax Credits (ITCs): GST/HST paid on goods and services imported into Canada are recoverable through ITCs. This refundable credit can be claimed by a GST/HST registrant to the extent that the amount was incurred in relation to commercial activities. To be eligible to claim ITCs, the claimant must generally be a GST/HST registrant prior to the transaction.
Flow-Through Input Tax Credits: Where an unregistered, non-resident company has paid GST/HST to import goods and services into Canada, they are generally not eligible to claim ITCs on the taxes paid. If the same imported goods and services are then delivered or made available to a GST/HST registrant in Canada, the registrant will be deemed to have paid the tax on the imported goods and services, and will thus be eligible to claim ITCs on the taxes paid.
If this approach is adopted, it is highly advisable for the Canadian registrant to acquire a ruling from the CRA about whether they are eligible to claim ITCs on the imported goods and services in such a transaction. A CRA ruling can greatly assist on potential future audits of the transaction.
Drop-Shipments: Drop-shipping is a technique whereby a vendor transfers their customer’s orders and shipment information to either a manufacturer or a wholesaler. It is the latter party who will then ship the goods to the customer, and not the original vendor.
A common “drop-shipment” scenario is where an unregistered non-resident company (USCo) has purchased goods from a GST/HST registrant in Canada (CanCo), and then USCo arranges for the CanCo to have the goods “drop-shipped” in Canada to another party on their behalf. Physically the goods never leave the country, but if the Canadian customer then provides a “drop shipment certificate” to CanCo, then CanCo will not charge tax to USCo, and USCo will not have to register to recover the amount of the tax paid.
The minutiae of drop-shipment rules can be complicated, and many companies will unfortunately misapply them. This misapplication creates situations where a tax risk can remain hidden until it is unearthed by a CRA audit at a later date. As such, companies should take great care and seek professional advice with regard to this technique to ensure that such risks are minimized at the outset so as to prevent unpleasant future surprises.
There are certain supplies of goods and services that are taxable at a rate of 0% – i.e., a zero-rated supply. Most tangible personal property that is exported from Canada will normally qualify as a zero rated supply and no GST/HST will be collectible. As a practical matter, if a purchaser plans to acquire TPP for export, and proper documentation is provided to the Canadian vendor, the purchase will be GST/HST free. There are, however, conditions that must be met for the goods to be considered zero-rated which include:
Importer of Record (IOR)
The IOR is the party who is responsible for clearing goods through Canadian customs. As such, the IOR is the registered party whose name will appear on the customs declaration (Form B4). The IOR can be, but is not always, the same party as the actual owner of the imported goods and services. While both the IOR and the actual importer will be liable for tax, it is important to note that only the actual importer will be eligible to claim ITCs for the amount of sales tax paid on the goods and services. Thus, the selection of an IOR is an important decision in the importation process, and companies should identify the best possible party to help them through the process.
Required to be GST/HST Registrant
In Canada, companies which are GST/HST registrants are obligated to collect and remit GST/HST on their supply of goods and services. While non-resident companies may not wish to be registrants, they must remain vigilant because there are a number of circumstances where a non-resident company can be compelled to become GST/HST registrants. Below are two common scenarios under which a non-resident company will be forced to register:
a) Carrying on Business in Canada
This is an undefined term in the Excise Tax Act although well canvassed by the case law. The CRA has stated that it will determine whether a particular person is carrying on a business in Canada and, therefore, required to register for GST/HST through an examination of the relevant facts, which include:
b) Permanent Establishment (PE)
A non-resident company that is determined to have a PE in Canada is considered to be a Canadian resident for purposes of the GST/HST to the extent its activities take place through their PE.
Except where the non-resident company is a “small supplier” (less than $30,000 in taxable supplies in a year), a non-resident company must register for the GST/HST if their commercial activity creates a PE. Determining whether a non-resident company has created a PE in Canada is a fundamental question. Whether a PE has been established or not is determined on a factual basis, but its salient feature is whether the non-resident company has established a fixed place of business in Canada. For companies who do not want to become GST/HST registrants, they must avoid creating a PE in Canada.
One consequence to establishing a PE in Canada is that the non-resident will no longer be eligible for zero-rating as many of the zero-rating rules require that the supply must be made to a non-resident party. This means that GST/HST will apply on its purchase of supplies from a Canadian registrant.
The import and export process in Canada operates under a complex legal and regulatory framework. It is important to have cross-border transactions reviewed in detail to ensure the best treatment under Canadian tax and customs law and to avoid unintended consequences.
TaxChambers LLP is collaborating with Andersen Global® in Canada.