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GST/HST REVERSE CHARGE SYSTEMS

SENIOR FINANCE OFFICIALS SEEM TO CONFIRM MORE ON THE HORIZON

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Mid-summer, the Department of Finance released important new draft legislation, putting in place a “reverse charge system” to deal with fraud in the Telecom industry. More recently – at the Canadian Tax Foundation’s Inaugural Commodity Tax Symposium – senior officials seemed to have suggested that more could be coming to deal with similar issues in other industries.

In this Indirect Tax Report, we review what a “reverse charge system” is and highlight the negative implications it can have on ITCs for innocent businesses purchasing from rogue suppliers.

What Is a Reverse Charge System?

A “reverse charge system” flips the normal GST/HST collection rules. Under the normal rules, a supplier charges and collects the tax from the recipient of its supplies, and the recipient – if registered, operating in commercial activities, and otherwise entitled to claim ITCs – claims an offsetting ITC in a subsequent GST/HST return. Under a “reverse charge” system, the supplier no longer charges or collects GST/HST, but rather the registered purchaser self-assesses and reports the tax on its own GST/HST return, offsetting any remittance obligation with an ITC claim, if entitled.

The advantage is that it prevents potential rogue suppliers from collecting GST/HST and running off with it. The clear disadvantage is that it puts all the risk on the recipient.

Potential Big Problems for Innocent Purchasers

The issue is that this system only works if both parties get it right, and the consequences of getting it wrong fall on the purchaser.

If a supplier charges GST/HST on a supply that is subject to the reverse charge, and the recipient pays it, the recipient cannot recover that amount by ITC (because it is not “tax paid or payable”). The only recourse is against the supplier – who could be long gone.

A recipient failing to self-assess – because it did not realize the reverse charge applied – is equally problematic (Here, the recipient would be exposed to potential assessment for unreported tax, plus interest and penalties).

If reverse charge systems are to be further developed in Canada, the Department of Finance needs to ameliorate these consequences for innocent recipients. A defence for innocent recipients has been suggested, together with additional time to correct matters where ITCs are disallowed because GST/HST was paid in error while the reverse charge applied. Another option is an automatic offset on assessment for GST/HST paid in error, so the same tax is not collected twice.

An ample notice, industry consultation and transitional relief before any new sector is added would also help.

Takeaways

Reverse charge systems will likely be expanded to more industries that just Telecom. Unfortunately, there can be big problems for innocent recipients, who will be required to implement new processes to ensure compliance is met.

Experienced Indirect Tax Counsel can help assess exposure and respond if the CRA come calling.

For help with GST/HST Reverse Charge Systems, please click here.