MORE ON THE  GST

Overview

Canada ’s federal value-added taxing system is called the Goods and Services Tax (the “GST”), and is provided for in Part IX of the Excise Tax Act (the “ETA”).

While commonly considered a single tax, the GST is actually imposed under three separate taxing divisions.  Each taxing Division is aimed at a distinctly different type of transaction.  Together, the three taxing Divisions create a comprehensive web of taxation, whose basic design is to tax virtually every domestic supply of goods, services, and intangibles, [i] as well as most goods,[ii] services, and intangibles “imported” to Canada. 

Under Division II of the ETA, for example, GST is imposed on domestic supplies, which are referred to as “taxable supplies made in Canada ”.[iii]  In turn, Division III imposes GST on most imported goods,[iv] while Division IV imposes GST on a number of “imported taxable supplies” – which are defined to include certain services and intangibles acquired outside of Canada , but consumed, used or enjoyed in Canada .[v]

On the other hand, the ETA also contains provisions aimed at relieving GST from most goods, services, and intangibles exported from Canada .  This is accomplished through extensive “zero-rating” provisions, enumerated largely in Part V of Schedule VI of the ETA.  This approach is consistent with the other aim of the ETA, which is to remove the GST from any Canadian goods, services or intangibles competing in the international markets.

What all of this also means is that persons engaged in even the simplest of corporate transactions often find themselves facing a number of very complex issues, sometimes resulting in the imposition of GST under one or more of Divisions II, III or IV, and sometimes, with proper structuring, resulting in the imposition of no GST whatsoever.  It should also be noted, with the fairly recent addition of an 8% “harmonized sales tax” (“HST”) in certain of Canada’s Atlantic provinces,[vi] that businesses with cross-border exposures in those provinces will now see that what was once a 7% risk, is now a 15% risk.  

Division II & “Taxable Supplies Made in Canada ”

When people speak of the GST, they are most often referring to the GST that is imposed by section 165 of the ETA, which is a Division II tax, applying to “every recipient[vii] of a taxable supply made in Canada ”.  While imposing a tax only on domestic supplies (i.e., taxable supplies “made in Canada”), Division II affects a large number of cross-border transactions, including supplies made in Canada by registered[viii] non-residents,[ix] unregistered non-residents who carry on business in Canada, and supplies which are drop-shipped in Canada on behalf of unregistered non-residents. Division II can also affect certain goods, services and intangibles seemingly exported from Canada .

There are a number of general rules governing when Division II tax will apply, and when a non-resident supplier will be required to “register” for the GST, and enter into the GST system, some of which are discussed below.

What is a “Taxable Supply” under Division II ?

Before attempting to determine whether a supply is made “in Canada” or “outside Canada” – and therefore “inside” or “outside” the scope of the Division II tax imposed by section 165 – an appropriate “first step” would be determining whether the particular supply is “taxable”, or whether it is “exempt” or “zero-rated”.[x]

A “taxable supply” is defined in subsection 123(1) of the ETA to be a supply that is made in the course of a “commercial activity”.  Since “commercial activity” is defined quite broadly, a taxable supply would generally include most supplies made in the course of a business, or in an adventure or concern in the nature of trade.  Significantly, however, a “taxable supply” specifically excludes the making of “exempt” supplies that are enumerated in Schedule V of the ETA.[xi]

Supplies Made “in Canada ”

If a supply is “taxable”, one can then proceed to determine whether that supply is made “in Canada ” or “outside Canada ”. [xii]  Section 142 of the ETA contains a number of general rules for determining when a supply is made “in Canada ”, usually referred to as the “place of supply” rules. Under these “place of supply” rules, one is theoretically able to determine how any supply connected to Canada will be treated for GST purposes.  For example, if the transaction involves a “sale of goods”, the supply would be considered to have been made “in Canada ” if the goods are “delivered or made available” to the purchaser “in Canada ”.  Other rules apply for other types of supplies (e.g., supplies of leased goods, services, intangibles or real property).

Special Non-Residents Rule

The “place of supply rules” found in section 142 must always be read in conjunction with a number of other rules which affect the determination of whether a particular supply is made “in Canada” for purposes of the Division II tax.  For non-residents, the most important of these rules is found in section 143 of the ETA, which we will refer to as the “special non-residents rule”.

The special non-residents rule deems all supplies of property and services made in Canada by non-residents to be made outside Canada , unless (a) the supply is made in the course of a business carried on by the non-resident in Canada , or (b) the non-resident was registered for the GST at the time the supply was made.  The effect of this rule is to make the ETA’s general “place of supply” rules inapplicable if the transaction involves a supply made by “unregistered non-residents”, not carrying on business in Canada .  When the special non-residents rule applies, it operates to deem any supplies made by the non-resident to be completely “outside” the GST system.  That means that the non-resident would remain completely exempt from any requirements to register for the GST, or to charge and collect the GST on its supplies made to Canadians.[xiii]

The potential significance of this rule makes the meaning of terms like “non-resident”, “registered”, and “carrying on business in Canada” quite important.

Residents & Non-Residents

While a complete discussion is outside the scope of this paper, the ETA does have rules regarding the meaning of “non-resident” and “resident”.  For example, section 132 of the ETA provides that a corporation will be considered a “resident” of Canada if it has been “incorporated” or “continued” in Canada , and not continued elsewhere.  A corporation will also be considered a “resident” if it satisfies the common law tests for residency namely, if the corporation’s “central management and control” is located in Canada .

While this might suggest that only corporations incorporated or continued outside of Canada – or with “central management and control” in Canada – will qualify as “non-residents”, the ETA’s “permanent establishment” rules can also affect that determination as well.

Permanent Establishments

Subsection 132(2) of the ETA deals with “permanent establishments” for non-residents, and provides that where a non-resident person has a permanent establishment in Canada , the non-resident shall be deemed to be resident in Canada in respect of, but only in respect of, activities that are carried on through that permanent establishment.  The effect of this rule is to exclude the “now-deemed-resident” from the application of the special non-residents rule in section 143 – although that exclusion would only relate to supplies carried on through the permanent establishment.[xiv]  This means that a non-resident with a Canadian permanent establishment might (unhappily) find that some of its Canadian business activities have succeeded in drawing it into the GST system, and requiring it to take positive steps to register for the GST, and to begin charging, collecting, and remitting the GST to the Canada Revenue Agency (the “CRA”).  Furthermore, and to the extent the non-resident becomes GST registered, the special non-residents rule would no longer be available to any of the non-resident’s activities.

In many respects, the significance of having a “permanent establishment” for GST purposes is not unlike the significance of having one for purposes of the Income Tax Act – as read in context of many of Canada ’s international treaties.

Carrying on Business

As previously indicated, the other main requirement for use of the “non-residents rule” in section 143 is that the non-resident must not be “carrying on business” in Canada . The concept of “carrying on business” is not defined in the ETA, and falls to be determined by the facts of the situation.  A number of legal tests have also been developed, largely from jurisprudence under the Income Tax Act.  As most readers will already appreciate, that jurisprudence suggests that to determine whether a person is “carrying on business” in Canada requires a factual-based analysis, focused on a couple of primary factors, and an inexhaustive set of secondary factors.[xv]  The two primary factors being:  

(a)  the place where the contract for the supply was made;  and

(b)  the place where the operations producing profits in substance take place.

In terms of the “place where a contract is made”, the jurisprudence generally accepts that the important elements of the contract are its offer, and its subsequent acceptance, and that the place the contract is “accepted” is the place where the contract for the supply is made.

Significantly, the CRA in its GST Memoranda Series 2.5 (Non-Resident Registration, June 1995) has confirmed that the concept of “carrying on business” ought to focus on the two primary factors above, with the place where a contract is concluded being the “place where the offer is accepted”.[xvi]  Based on these two factors, the mere advertising of products for sale in Canada (invitations to treat and not formal “offers for sale”) has not generally been regarded as sufficient activities to result in the carrying on business in Canada .

More recently, however, the CRA has detracted from its focus on two “primary factors” referred to above, in favour of a more general “place of operations” approach, set out in a July 2002 Technical Information Bulletin B-090:  GST/HST and Electronic Commerce.

The upshot of this new approach is that the CRA has effectively done away with the “place the contract was made” criteria – relegating it to just one of a number of criteria that are relevant to determining the “place of operations”  – and thereby increasing the uncertainty of non-residents attempting to understand whether they are required to register for the GST.[xvii]

It is apparent that these changes were developed by the CRA because of some concerns that electronic commerce-type businesses might be gaining an unfair advantage in Canada (i.e., relative to their “brick and mortar” competitors, it was much easier to avoid registration for the GST). 

One hopes that they have not sacrificed the certainty of the many to address a few specific (and unique) problem areas.

On the other hand, some of the examples in the E-Comm Bulletin are a bit surprising.  For example, in the context of a supplier of downloadable audio files, the CRA has confirmed its view that the following factors are not sufficient to establish the carrying on of a business in Canada :  

1.        Advertising that is directed at the Canadian market through a U.S. based web-site;

2.        Concluding contracts in Canada; and

3.        Processing payment in Canada.

Having said all of that, the bottom line here is that most non-residents will want to ensure that they are “unregistered and “not carrying on business” in Canada – so as to ensure the proper application of the “non-residents rule”.

Where they are “carrying on business” in Canada, or otherwise choose to “voluntarily register” (see below), the Division II tax will be payable, and the non-resident will have a contemporaneous requirement to register for the GST, and begin charging, collecting and remitting that Division II tax to the Canadian government.

Voluntary & Mandatory Registration Rules

Special rules in subsection 240(3) of the ETA permit persons engaged in a commercial activity in Canada , and certain non-residents with more limited ties to Canada, to voluntarily apply for GST registration.

These “voluntary registration” rules were broadened in 1996 and extend voluntary registration to non-residents who regularly solicit orders for the supply of goods to Canada , as well as non-residents who supply services to be performed in Canada , and intangibles that are to be used in Canada or otherwise related to Canada .

Note that while GST registration is sometimes voluntary, it is often mandatory and, subject to a special $30,000 “small supplier” rule, which would actually require most persons carrying on a business in Canada, and making taxable supplies in the course of a commercial activity to register.[xviii]

Why A Person Might Voluntarily Register

Even if a non-resident successfully ensures that its business activities are not “carried on in Canada”, there may be advantages to registering for the GST, such as the eligibility to recover the GST that they themselves pay on their inputs through claiming input tax credits (“ITCs”).  This follows from section 169 of the ETA, which allows registered persons to claim ITCs, to the extent they were engaged in “commercial activities”.[xix]  For example, for non-residents who are required to pay GST in order to carry on their activities (e.g., a non-resident selling goods into Canada on a delivered basis, who would be required to pay the GST at the border, under Division III – see infra), registration may provide an opportunity to fully recover the GST resulting from these activities.  While there are other ways of unlocking the GST (e.g., ITCs under section 180), many times, simply registering for the GST is the easiest process to recover the GST.

On the other hand, with GST registration comes the administrative headaches of properly complying with one’s GST obligations, which include regularly filing GST returns, ensuring that the GST is properly charged, collected and remitted, and a whole host of other obligations and considerations.

Division III & “Imported Goods”

Division III is entitled Tax on Importation of Goods, and imposes tax on “every person who is liable under the Customs Act to pay duty on imported goods, or who would be so liable if the goods were subject to duty”.[xx]   Accordingly, the Division III tax applies to most goods imported into Canada .

Somewhat like the situation under Division II, the non-resident supplier of the imported goods is under no obligation to charge or collect tax.  On the other hand, since the “importer of record” is generally the one paying the Division III tax when clearing the imported goods at the border, a non-resident might well find itself on the “paying” end of the equation – but that would usually depend on what its “delivery terms” were.  Thus, even if an unregistered non-resident has successfully shielded itself from any Division II tax obligations – perhaps because of the special non-residents rule in section 143, and the fact that it does not “carry on business” in Canada – the Division III tax can still apply to the goods being imported to Canada.  Furthermore, and because there is no provision in the ETA creating a mutual exclusivity between Division II and Division III taxes, a potential for “double-taxation” does exist in these types of cross-border transactions, with both Division II and Division III tax being payable in some instances.

De facto Importer

Proposed section 178.8 of the ETA is a complex provision aimed at addressing the de facto importer or “constructive” importer issue.

In simple terms, this issue occurs when goods are supplied outside Canada and subsequently imported into Canada with the supplier, rather than the recipient of the supply, acting as importer of record, and thus paying the Division III tax (and applicable duties) and claiming an ITC.

The CRA takes the position that since the supplier is not the user or consumer of the goods in Canada nor importing the goods for the purpose of supplying them in the course of their commercial activities – which are prerequisites to ITC entitlement pursuant to paragraph 169(1)(c) – they are not entitled to claim an ITC.  Whether the CRA’s position is correct is debatable.  On the other hand, the CRA seems to have prorogued any further debate on the issue by causing the Department of Finance to propose these amendments.

The new section 178.8 is aimed at ensuring that it is only the recipient of the supply (i.e., the “de facto importer”, in the CRA’s vernacular) that is entitled to an ITC for any GST paid at the border – under the CRA’s theory that only the “recipient” would be the user or the consumer of the goods in Canada .[xxi]

While this amendment would not normally impact a corporate reorganization, to the extent that property is imported to Canada as part of reorganization, these rules should be consulted.

Division IV & “Imported Taxable Supplies”

The third taxing division under which GST might be payable is Division IV, which is entitled Tax on Imported Taxable Supplies Other than Goods, and which imposes tax on “every recipient of an imported taxable supply”.

Since an “imported taxable supply” is defined quite broadly, Division IV captures most transactions not otherwise taxable under Divisions II or III and, as indicated above, can catch a number of international transactions involving services or intangibles.  The rules defining “imported taxable supplies” are remarkably complex, and to the extent taxpayers are again involved in somewhat less than “exclusive” commercial activities, special attention should be paid to these rules.  They will create a self-assessment tax in respect of amounts paid abroad for the use of intellectual property, and other intangibles or services, to the extent the services or intangibles that are being acquired for use otherwise than exclusively for commercial activities.  In other words, if a Canadian resident is involved in some exempt activities, there may well be a Division IV self-assessment obligation imposed on it each time services or intangibles are acquired abroad.

ENDNOTES

[i]    For “domestic” supplies, the principal exceptions are goods, services, or intangibles enumerated in Schedules V or VI of the ETA, which provide for certain “exempt” and “zero-rated” supplies, respectively.

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