Four common GST/HST audit risks facing Canadian registered businesses
Minimize risk of assessment after an audit by focusing on key areas
INSIGHT ARTICLE |
When dealing with a value-added tax like the Canadian goods and services tax (GST) or harmonized sales tax (HST), taxpayers should consider not only that tax is collected appropriately, but that all available refunds are claimed. However, when the Canada Revenue Agency (CRA) contacts your company and decides to conduct a GST/HST audit, there are a number of issues with respect to tax collected and claimed that may arise during the course of that audit. Listed below are four common audit issues.
1. Using the correct rate of tax
It is the vendor’s responsibility to collect tax at the correct rate. GST or HST applies to taxable supplies made in Canada at rates currently ranging from 0 percent, 5 percent, 13 percent or 15 percent. If tax is applied at the incorrect rate, a vendor may have a liability.
Place-of-supply rules are used to determine whether a particular supply is made in or outside of Canada. For supplies made in Canada, additional place of supply rules are used to determine the province (and, therefore, the applicable rate) in which a supply is made. Different place of supply rules are used for different types of supplies:
Sale of goods: Where goods are supplied by way of sale, the place of delivery determines the place of supply. “Delivery” does not necessarily mean physical possession. Legal delivery is generally the place where title to the goods is transferred. However, there are some exceptions to the general rule. One such exception is where a vendor arranges for the transportation of the goods being supplied. In this case, the place of supply is determined by the final destination of the goods. Where charges for goods and freight are listed separately on an invoice, the freight should generally be charged at the same rate as the goods.
Supply of services: The general rule for the supply of a service is based on the billing address of the recipient. As an example, a consulting service performed in Ontario (where the HST rate is 13 percent) but billed to a recipient in Alberta (where the GST rate is 5 percent) would be subject to 5 percent GST. However, there are many exceptions to this general rule that may end up with a different result.
Exceptions to the general rule for the supply of a service include:
- Services in relation to tangible personal property–such as repairs to equipment situated in Canada
- Services in relation to real property–such as architectural or engineering services
- Passenger/ freight transportation services
- Personal services–can include training services rendered in Canada
- Services rendered in connection to criminal litigation
- Telecommunication services
- Services related to a location specific event–such as a concert
Each of these services has its own set of rules to be applied. Therefore, it is important to identify the type of supply being made so that the correct place of supply can be applied.
Intangible personal property: Licenses to use computer software, patents or copyrights are intangible personal property. It is often difficult to determine the place of supply as these supplies may be made globally or across all of Canada.
Rate changes: The applicable rates of GST/HST are changed from time to time. For example, the HST rates in Newfoundland, Labrador and New Brunswick were increased from 13 percent to 15 percent effective July 1, 2016. When a rate change is made, transitional rules are used to identify supplies that are made before or after the rate change.
2. Related party transactions
Tax on inter-company charges, especially when made by making a journal entry, is often ignored. Failing to collect the applicable tax results in a liability even in situations where the recipient would have been entitled to claim a full refund of the tax had it been charged.
Certain elections can be made to not have tax apply on charges between closely related persons. An election is not valid unless all of the requirements are met. Some elections were previously not required to be filed, and instead, simply kept on hand. However, recent legislative changes now require all elections to be filed. These elections are not available to non-residents. Therefore, persons relying on an invalid election would have a liability for failing to collect tax correctly.
3. Incorrectly zero-rating exported supplies
Exported supplies of goods and services are generally zero-rated (taxed at zero percent, or no tax collected) for GST/HST purposes. There are many exported supplies that are excluded from being zero-rated. As an example, a service provided to a non-resident that is in relation to tangible personal property situated in Canada is excluded from being zero-rated.
4. Documentary requirements
GST/HST is a value-added tax. This means that refunds can be claimed to recover the GST/HST incurred in the course of a person’s commercial activities. Where a refund of tax is claimed, certain documentary requirements must be met as evidence that the tax was indeed charged. In the event of an audit, the CRA will deny any refunds that are claimed without the proper documentation.
Perhaps the single most common issue identified in an audit is that refunds are not supported by the proper documentation. The following information is required to support refunds of GST/HST:
- Correct name of the recipient, should be no ambiguity as to recipient – example: ABC Distribution Inc. operating as ABC Inc.
- Must be recipient of supply–person legally obligated to pay for supply
- GST/HST registration number of the supplier
- Written agreement to document agency relationship where other parties are paying invoices
- Price adjustments–Where tax has been charged or collected and selling price is subsequently reduced, optional for supplier to reduce or refund the tax. Documentation should contain prescribed information
- Electronic documents–must contain all required information
The issues discussed above are just some of the more common audit issues that result in an assessment for failing to collect the appropriate amount of tax, or denials of GST/HST refunds.