Carousel Scheme Defence
MILLAR KREKLEWETZ LLP is a boutique Canadian law firm with lawyers who have significant expertise in carousel scheme matters, including defending businesses/directors accused of same or 'sham transactions' by CRA in the course of an assessment.
The following is a short introduction to carousel schemes in Canada.
Please note, this background is intended for informational purposes only and does not constitute legal advice on any issue. We would be pleased to provide specific and current advice to your specific situation, if desired.
Carousel Schemes Defence
Carousel Schemes – General
The Canada Revenue Agency (“CRA”) uses the term “carousel scheme” to describe a situation where (in CRA’s view) a group of GST/HST registrants work in collusion to create a fake supply chain in order to generate false GST/HST refunds.
According to CRA, in its simplest form, a carousel scheme “is an arrangement where [the] GST/HST... collected on goods that are part of a resupply chain is never reported and at least one member of the supply chain goes missing (missing trader). The missing trader registers as an annual filer and goes missing before they remit any GST/HST … [and] they are set up for the sole purpose of perpetuating the scheme.” CRA also observes that “[s]ales invoices are issued in the name of the missing trader and the purchasing companies are monthly or quarterly filers that claim their input tax credits from these invoices”.
Essentially, a carousel scheme usually generates money by artificially putting multiple participants in a position to recieve a GST/HST refund as a result of their supplies to a "missing trader". The participants get their refund (since they are frequent filers) and the missing trader (who is typically an annual filer) fails remits any GST/HST (leaving the Minister out of pocket for the value of the refund).
According to CRA, the subject goods in the scheme can change hands up the supply chain several times or only once, with the goods eventually ending up with an entity where the tax status of the good changes – e.g., goods have been processed into zero-rated goods (e.g., the process of refining scrap gold into pure gold) or are said to have been exported on a zero-rated basis or supplied outside of Canada on a non-taxable basis.
CRA internally refers to the last supplier that "changes" the tax status of the supply as the “zero-rater”.
At this point, the CRA seems to suggest that the original goods, or a portion of the original goods, are returned back into this system, at the start of the supply chain, either as consideration for supplies previously made, or the cash earned by the scheme is used to make new purchases – with this carousel type process repeating many times. In some instances, the CRA suggests that the “goods” at the heart of the carousel scheme may not even exist!
CRA also points to other examples where there may also be multiple carousels within the group, with one or two points in common. That is, they may have the same missing trader, or the same zero-rater.
Common to these schemes, says the CRA, is that the GST/HST collected by the missing trader is not remitted to the Canadian government, either through non-filing, under-remitting or non-payment of the amounts due. The zero-rater claims an input tax credit for the amounts charged by the missing trader, resulting in net revenue loss to the government.
In this world, it appears that the CRA’s “carousel schemes” require at least one zero-rater and at least one missing trader. Without a zero-rater to receive GST/HST refunds from CRA, there is no source of cash in the scheme, and without at least one missing trader there is no tax leakage at the bottom of the supply chain. On their face, the transactions appear legitimate, and in most cases appear to follow all documentary requirements prescribed in the Excise Tax Act.
CRA has apparently tasked its Audit Branch to question the motivation and benefits behind these sort of transactions, advising Audit that in true “carousel schemes”, the structure of the transactions within the colluding group is generally manufactured to create GST/HST refunds, which may in fact be the only source of funds. This schemes are identified by looking at the entire supply chain to develop a complete picture of what is occurring. While such schemes are “difficult to detect, as the books and records are prepared based on transactions intending to deceive”, the CRA cautions that the “more complexity that can pe introduced into the supply chain, the more difficult it is for audit to detect the scheme and gather sufficient audit evidence”.
CRA Audit Initiative
With these ground-rules in mind, it appears that “carousel schemes” have been a recent area of focus for CRA auditors, leading to significant ITC denials and/or large assessments being brought recently against businesses in a number of industries, including the scrap gold and the telecommunications industries: see for example, Express Gold Refining Ltd. v. Canada, 2020 FC 614 and Iris Technologies Inc. v. Canada, 2020 FCA 117.
Companies that have their ITCs denied as part of a CRA “carousel scheme” assessment may typically find it difficult to turn CRA around at the Appeals Stage (i.e., CRA has already made up its mind at this point). Reference to proper ITC documentation (including GST Registration numbers for all suppliers charging GST/HST) is often summarily dismissed by CRA, based on its viewpoint that carousel schemes usually appear legitimate and can appear to follow all ITC documentary requirements under the Excise Tax Act and Regulations. As a result, maintaining pristine ITC supporting documentation often ends up being the last nail in the coffin with the CRA on Appeal, with CRA looking at this type of proper legal compliance as confirmation of something nefarious in the background.
The broad net cast by CRA also catches otherwise legitimate businesses who unwittingly appear in a chain of suppliers accused of participating in a carousel scheme!
As a result, challenging and defending these type of carousel assessment is very challenging, and almost always required specialized or expert tax litigation support.
Millar Kreklewetz LLP has significant experience with carousel scheme audits and assessments, and defends these at both the CRA Appeals stage, and before the Tax Court of Canada.
Further Help with Carousel Schemes
Millar Kreklewetz LLP is well-placed to provide assistances with all carousel scheme related matters, and persons in need representation with respect to an allegation by CRA of same are encouraged to use the form on this page to contact us for specific legal advice applicable to their unique fact situation.